August 13, 2023

Personal Loan with Collateral: Secured or Unsecured?

There are benefits and drawbacks to both sides of the argument over whether to take a secured or unsecured loan, but the final decision comes down to answering two questions:

  1. Do you have a valuable piece of collateral, typically a home or automobile?
  2. Are you willing to risk losing that asset if you can’t make payments on the loan?

If you can answer “Yes” to both questions, a secured loan is the route to take. There are many more benefits to a secured loan for the obvious reason that you stand to lose a lot if you don’t make payments. Additional benefits include:

  • It’s easier to qualify for a secured loan because you have collateral.
  • You should receive a better interest rate. The collateral used to secure the loan has value, which makes you less of a risk. The lower the risk, the lower the interest rate on the loan.
  • You should be able to borrow more money, based on the value of the collateral.
  • You may not need a job. Lenders prefer the borrower to have a job, but if job loss is the reason for the loan, employment is less of a factor, especially if there is good collateral backing the loan.
  • The primary benefit of an unsecured loan is that you won’t lose any assets, meaning home or car, if you can’t make payments. Additionally, unsecured loans are easier to dismiss in bankruptcy court.

Applying for a Personal Loan

The application process for personal loans should be easy, as long as you answer the questions in detail and can verify your work and credit history. Before you start filling out the application form, take a few minutes and answer some questions:

  1. What is the purpose for the loan?
  2. What is your credit score and what type of interest rate do you expect to receive based on that score?
  3. How much are you going to borrow and can you comfortably afford the payments on that amount?
  4. How long a repayment schedule can you handle and do you want a secured or unsecured loan?

Once you have the answers, gather documents required to verify financial information. You may need tax returns, checking and savings account information, deeds for property and titles for cars. You may need all or parts of that list, depending on the size of loan you’re seeking.

Finally, you will need the usual personal information, name, age, address, social security number and contact numbers, and something to verify each one.

Many loan applications are rejected because the borrower couldn’t provide documentation needed for approval. It’s important to assemble all necessary paperwork together before you start filling out the application.

One more bit of advice: Shop around. It may feel you’re begging for help when you start the process, but the truth is, you’re the customer. If the lender wants your business, they will work with you to get a deal done. If not, keep shopping.

Qualifying for a Loan

Since most personal loans lack collateral, lenders will scrutinize your credit history, your income and your debt level before approving financing. Your credit history, and your credit rating, will help determine how much interest you’ll pay. The lower your credit score, the higher the interest rate and the less you’ll be able to borrow.

Since there are many varieties of personal loans, there’s no single formula for qualifying to borrow. Payday lenders, for instance, will often loan money in anticipation of a paycheck or a tax refund. Payday lenders often require a credit check, but might charge interest rates of 400% or more. The high interest can prove disastrous for borrowers, so be wary of such lenders and always consider the terms of the loan. Too many borrowers fail to understand how interest accrues and come to regret their decision.

Some lenders will transact with people will low credit scores but will charge relatively high interest rates – often has much as 36%.

As a rule, avoid payday lenders and carefully evaluate repayment terms and interest rates before borrowing. Personal loans can be cheaper than credit card balances and offer a way to consolidate several debts into one.

Credit card debt is revolving debt while personal loans are installment debt. Credit rating agencies treat revolving and installment debt different, and transferring debt from revolving to installment can improve your credit score.

How is My Credit Affected by a Personal Loan?

If you are using a personal loan to consolidate and pay down credit card debt, you might discover that you credit score improves rapidly. A significant part of a credit score is based on credit utilization, which is the percentage of your credit in use. Since personal loans generally don’t involve a credit line, transferring debt from revolving credit card debt to the installment debt of a personal loan will lower your credit utilization amount, and that will have a favorable impact on your credit score.

Personal loans can help you rebuild credit and pay off debt without the help of a debt consolidation firm. This can save you money, but it isn’t an option for everyone. If your credit score has dropped below 580 as the result of high amounts of revolving debt, it is unlikely you will be able to find a personal loan that makes financial sense. Before seeking a personal loan, it pays to know your credit score and find out what interest rates lenders charge. The lower your score, the higher your interest rate will be.

If you think you’ll have a hard time making on-time payments on your loan, think twice about borrowing the money. Defaulting on a personal loan can severely damage you credit score if the default is reporting to one of the rating agencies. If you borrow the money from a family member and fail to repay, you might lose an important relationship and if you signed a contract, you could be sued. So always think ahead.

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