Getting loans is a necessary part of anyone’s financial life. Because of this, it is important to understand the different types of credit available on the market today. When looking for a loan, there are two main types of debt. In other words, all debt can be described as either secured debt and unsecured. Each of these types of debt has distinct advantages and disadvantages.
Secured debt is a loan backed by an asset or collateral. Collateral is an asset that can be repossessed or taken back by the lender if the borrower cannot or will not make their loan payments. Examples of secured debt include home mortgages and auto loans.
Because a bank or lender has the option and ability to take the collateral put up by the borrower, secured debt usually has a lower interest rate than unsecured debt. Usually, the amount of credit that is extended for these loans is based on several factors, but the main factors that determine how much credit is extended are the credit history of the borrower and the assessed value of the collateral assets. For example, for a mortgage the amount of credit extended is based on the credit history of the borrower, the amount the borrower can repay, and the value of the home that is being purchased. These loans usually tend to be granted for higher amounts than unsecured loans.
Unsecured debt, on the other hand, is debt that is not backed or insured by any collateral assets. Examples of this type of debt include most credit cards, payday loans, and personal loans. Having unsecured debt means that nothing can be repossessed or taken back by a bank in case the borrower cannot or will not pay. In other words, the lender cannot take away anything the borrower owns. It also cannot garnish the wages or Social Security of a borrower.
Unsecured debt is extended to a borrower based only on his or her credit score and perceived ability to repay the loan. Consumers who have better records and higher income levels can usually get better interest rates than others on these loans. On the other hand, consumers with poor credit histories are usually denied these loans. Since there is no collateral asset for a bank to take back if the consumer doesn’t make their payments on time, the total amount of credit granted as unsecured debt is usually lower than the amount granted as secured debt.