The Difference Between Secured and Unsecured Loans

So, what is the difference between a secured loan and an unsecured loan? Well, a secured loan is considered a safer loan by lenders because the loan is “secured” by a tangible asset. For example, when a bank gives you a secured loan for a car, if you don’t make your payments or end up defaulting on the loan, they can repossess the car. Having the option of taking the car back at least gives the bank some security when they loan you money. Unsecured loans are riskier to the lender because there is no asset tied to the loan. The bank simply chooses to make you a loan based on your credit score and whether they think you are a good credit risk. These loans are also sometimes referred to as signature loans, payday loans, personal loans, or installment loans.

Pros and Cons of Unsecured Loans

One of the pros of unsecured loans is that if you are needing quick cash, this may be a viable option. Unsecured loans are also perfect for people who don’t have anything of value to offer as collateral. Although the lender may ask you what you intend to spend the money on, you will have more flexibility with the money than with a secured loan. For example, a secured car loan may only be spent on a car, while unsecured loans can be used to pay off any sudden unexpected debt like medical bills, car break downs, or a security deposit for a new apartment.

Some of the cons of unsecured loans are that they can be very expensive, especially be careful of payday type loans and other loans from check cashing places. These places charge outrageous interest rates, sometimes as high as 300+% yearly interest rates. However, if you don’t use a payday lender and instead opt for a traditional lender such as a bank or credit union for your unsecured loans, then you may need to have good credit. While payday lenders may lend money to anyone with a pulse, traditional lenders look for credit worthiness before giving loans. The good news about going with a bank or credit union is that the rates will be much better than those of the average payday lender.

Payday Loans

A payday loan is also another type of unsecured loan that you typically see offered at check cashing places rather than banks or professional lending organization, these loans may also sometimes be referred to as cash advances. Payday loans are typically for small amount of money that is loaned for a very short time frame. The way these loans usually work is that the customer gives the payday lender a postdated check, which the lender keeps on hand while the customer is given cash in hand for the postdated check.     

Pros and Cons of Payday Loans

The pros of payday loans are pretty limited – quick cash.

However the cons of payday loans are extensive. These loans are so controversial that they have been actually outlawed in these following state:

• Connecticut
  
• Georgia
• Maine
• Maryland
• Massachusetts
• New Hampshire
• New Jersey
• New York
• North Carolina
• Ohio
• Oregon
• Pennsylvania
• Vermont
• West Virginia

The reason these types of loans have come under such scrutiny is because of the almost criminal interest rates they charge. Some states have usury laws that prohibit lenders from charging unreasonably high rates of interest, but payday loans got around these usury laws by partnering with banks in states that don’t have usury law, effectively allowing them to skirt the intent of the law. This is legal because loans are subject to the rules where the bank is located not the state where the borrower is located. Guidelines that the FDIC passed in 2005 stated that payday loans could no longer be rolled over indefinitely, after 6 renewals the payday loan would then have to be changed to a traditional long term loan with more reasonable interest rates. Because of these rule changes, since 2007, no more banks are partnering with payday lenders.

The payday loan industry counters with the argument that they provide a service to the low income community who may not otherwise be able to get a loan. However it’s hard to sell the idea that you’re helping low income people when you’re charging 300+% interest rates.  

In Summary

Keep in mind that unsecured loans should be used sparingly and only in extreme emergencies, you should never use unsecured loans for vacations or other non-essential things.  A lot of people end up getting caught in the vicious cycle of payday loans and can never get caught up. If possible, get the unsecured loan from a bank or credit union and always use credit responsibly.