Secured and Unsecured Loans - Which is Better?
by: WilliamBlake |
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Both lender and borrower are faced at the outset with a basic decision - to obtain a loan that is either secured or unsecured. But, what does that mean, and what are the pros and cons of each for either party?
The most common type of secured loan is a mortgage. The Borrower makes a commitment to repay the loan in accordance with its terms. The mortgage is secured by the Borrower's home which means if he fails to pay the lender can confiscate the home as payment. All secure loans and guaranteed by some type of real or personal property which can be taken in the event of a default of payment.
This is serious because it means if you default on even one payment the lender can take your home in foreclosure and sell it for payment of the debt. In reality, the lender would not take such aggressive action after only one missed payment. The foreclosure and sale of a home is a long and costly process that lenders try to avoid if at all possible.
The truth is that lenders will wait a long time before resorting to foreclosure. Even after several months of default payments the lender will continue to try aggressive demand letters to motivate the Borrower to pay. Even when the real estate market is good for selling homes, lenders would focus their time and resources in other things besides foreclosures and sales.
Nevertheless, it's wise to realize that the lender has this right. How important or not that right is can be judged by recognizing that even with an unsecured loan, creditors have the legal right to seize assets like salary, stocks and property. This requires only undertaking a relatively simple and inexpensive legal procedure to declare the borrower in default.
However, taking legal action is still an expense for the lender and requires some time and effort that they would rather not sacrifice. In most cases, they prefer to work out a payment arrangement.
Typically the interest rate on an unsecured loan is higher than secured loans. This is because the lender is taking a greater risk since the money is not secured by assets or property.
The lender in that case is taking a larger risk, and they are compensated by charging higher interest. That covers losses from defaults (which are higher on unsecured loans) and is one way to change borrowers incentives. Most people will try much harder to meet a debt that is tied to their home than for an unsecured loan.
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