14 Dec The Difference Between Secured Loan and Unsecured Loan
When taking out a loan from a financial institution, you will need to decide between a secured and unsecured loan. Each of which has different terms and conditions that regulate how the exchange proceeds. Which should you be taking? As an experienced and licensed moneylender in Singapore, we often come across new clients who are unsure of this choice.
How people get their information
In particular, they often depend on street hearsay or advice from non-professionals. As a result, they often then land themselves in relatively unfavorable or illogical situations. To help bridge this gap in knowledge, we have written this article to clearly define the differences. Furthermore, we will be looking at which situations are applicable under each type of loan.
Understanding the premise of a loan
Before we jump into defining an unsecured loan or secured loan, we need to first understand the premise of any loan.
Borrowing and repaying
In the simplest of terms, a loan involves you borrowing money from another entity for a duration of time. At some point, or various points, you will have to make repayment(s) for the loan. In return for not having the sum of money of the loan for its duration, the lender will request compensation from you.
The objective of interest
This compensation comes in the form of interest you pay back to the lender. In this way, the lender is compensated for the loss of the time value of money and opportunity cost loss during the period. Typically, interest is applied in the form of percentage tagged to the principal sum and is applicable per time period. As such, this suggests that the longer you take to pay back the loan, the most interest will be accumulated.
The risky nature of loans
Take a moment to get into the shoes of a financial institution extending loans to debtors. On the surface, a loan is a tremendous way to make more money. You would lend a sum of money to a borrower, then sit back and wait to collect interest, thus growing your wealth. At the end of the day, under this scenario, you would be in a win-win situation.
However, just like anything else in life, there are downsides to all circumstances. In this case, lenders would need to take on the risk of the debtor not be able to pay back the loan. Also known as a default, under this situation, the debtor would not make good on the loan. In other words, you will be losing a good part of or even the total sum of the loan.
Financial institutions constantly need to gauge the level of risk involved in extending you a loan. Likewise, it is this level of risk that determines the level of interest charged. It is also at the heart of the topic at hand, unsecured loans versus secured loans.
One way for financial institutions to address the aforementioned risk is through secured loans. The premise of a secured loan is that it involves a pledge of collateral on your part for the loan. This would mean that the loan is backed by your asset that would be repossessed by the lender should you not be able to repay the loan.
Commonly, the asset would be that of a house or car that you own. Furthermore, should the collateral be insufficient in value to cover the debt, you would still need to top up the difference.
Having said that, a collateral is also a mechanism for the debtor to recover the asset should you default on the loan. Subsequently, this asset can be resold in order to recoup a minimum sum and thus cutting the losses.
Th risk of you defaulting on a secured loan is relatively lesser as you have much to lose in forfeiting the asset. Consequently, the lender has a lower level of risk and thus is more willing to extend you a loan more often than not under this arrangement. Furthermore, interest rates in secured loans are also lower in accordance with the lower risk.
It should be noted that once the loan is made, borrowers often have to take action to maintain the pledged asset’s value. For example, the contract would often mandate that you have purchased insurance for your house or car. This ensures that in the event of any accident, the value of the asset is not lost.
As suggested in the name, an unsecured loan is does not involve a pledged asset on your part. This thus means that should you default on the loan, the debtor cannot seize any of your assets. Instead, in order for a debtor to recoup losses, they would need to initiate a lawsuit against you.
Since there is no collateral involved, the debtor is extending you a loan purely based on your word to make good on it. In a way, you can see this as a basic sign of trust between them and you. How do creditors ascertain if you are trustworthy then?
The answer lies in your credit score and report. This metric and report take into account your credit history and income among other factors that determine your credit worthiness. In other words, it indicates to financial institutions how likely you are to repay the loan in full and on time. Should you have a poor credit score, then you may face one of the following:
- An unwillingness to extend to you larger loans
- Higher interest rates attached to loans
- A complete unwillingness to extend loans to you
The upside of an unsecured loan is that it is offered in relatively fast fashion. Oftentimes, you can get a loan within a day and do not suffer any immediate downside. An example of an unsecured loan is that of a personal loan in Singapore, which lends you a sum of money for whatever needs you have in a fuss free fashion. Other common examples include that of:
- Medical loans
- Student education loans
- Retail installment contracts
- Credit card bills
- Line of credit
Common to all these products is higher interest rates attached in order to compensate for the lack of security.
For more information on your credit score and how to improve it, do read https://jdcredit.com.sg/how-is-your-credit-score-determined/
Choosing between secured and unsecured loans
As alluded to earlier, if you do have an asset of value to pledge, you will find it easier to get a loan and at more favorable rates. This is why a secured loan is easier to get and typically offers you better terms. However, a con of secured loans is the typical longer time needed for it to be processed. This is due to the amount of verification needed to determine the value of the asset and the protection it has.
On the other hand, unsecured loans can be processed fast as it is based on your credit score. It should be noted here that there is no hard and fast rule as to what is a good or acceptable credit score. Instead, each financial institution determines their comfort level with extending you a loan based on their own acumen or internal scoring metrics.
Lastly, you should also consider the size of the desired loan. Naturally, if the loan amount is high, then expect to not find any unsecured loan offers on the market. Instead, you will have to pledge some form of asset to the loan.
Enquire For a Loan From JD Credit
Here at JD Credit Pte Ltd, we strive to achieve each and every one of our customers’ needs and wants. We are an organisation that provides loans with the best rates to any individual that is approved by the IPTO (Registry of Moneylenders). Our team of well trained and experienced staffs are obliged and dedicated to help our customers with their financial matters. Our vision is to achieve excellence when serving customers provide the best information and finest service for our customers and lead in the money lending industry.