Personal loans come in two varieties: secured and unsecured. The type you choose will depend largely on what you need the loan for, and how much you need to borrow. Personal loans are typically used to finance debts that other brands of loans cannot cover: for example, you can take out a mortgage to finance a home purchase, so you would not need to take out a personal loan to cover it. On the other hand, you might need to borrow money to furnish your new home; in that case, you might apply for a personal line of credit to fund your new furniture purchase.
Unsecured Personal Lines of Credit
An unsecured personal line of credit, or unsecured personal loan, is made by a lender without requiring collateral on the loan from the borrower. Collateral is valuable property the borrower pledges against the value of the loan. If the borrower defaults on the loan, the lender can collect the collateral and may keep it or try to sell it to offset the balance owed on the loan. Because unsecured loans pose a greater risk to the lender, they generally carry a higher interest rate than secured loans. However, they are the most common kind of personal loan to obtain, as borrowers usually use these funds to consolidate debt, fund large extraneous purchases, or pay off medical debt.
Secured Personal Lines of Credit
A secured personal line of credit, or secured loan, is made by a lender to a borrower who has pledged collateral against the value of the loan. This collateral must be liquid enough to be sold quickly and at some value in the event the borrower defaults. Common types of collateral include: jewelry, vehicles such as motorcycles or scooters, musical instruments, antiques, and the like. Because the risk to the lender is lower than with an unsecured loan, these loans generally carry a lower interest rate. On the other hand, the lender and the borrower may disagree about the value of the collateral; therefore, the borrower should have a written appraisal from a third-party available when pledging collateral against a loan.
Which Loan Type is Best for Your Situation?
Generally speaking, if you take out a secured personal loan, you should be prepared to lose your collateral; that is, don’t pledge a family heirloom if you may not be able to pay the loan back. Unsecured loans don’t carry the same risk to the borrower but they do cost more in the long run due to the higher rate of interest. Whether you take out a secured or unsecured line of credit, never borrow more than you can pay back within a reasonable amount of time.