A secured loan is a loan backed by collateral - something of value that you own - and pledge to a lender to insure payment. You make a promise, usually in the form of a printed security agreement, stating that the creditor, or person or company you owe money to, can take a specified item of your property if you fail to pay back the loan. An unsecured loan is a loan not backed by collateral - anything you own can be taken by the lender if you can't pay the debt.
For secured loans, often, the item pledged is the one being purchased. The pledged item can also be an item that you already own. If you stop paying for any reason, the pledged item goes to the creditor.
The most common items purchased by a secured loan are:
- Houses and condos
- Motor vehicles (cars, trucks, and motorcycles)
- Major appliances (refrigerators and washing machines)
- Furniture
- Expensive jewellery
Generally speaking, secured loans are high priorities in your debt repayment plan, especially if the loans are for a home or transportation. You may be willing to have someone repossess a diamond necklace, but you certainly don't want anyone foreclosing on your mortgage and repossessing your home.
Unsecured loans
The majority of debt for most people is in the form of unsecured loans - primarily credit cards - but this category also includes student and personal loans, and dental bills. Personal loans are unsecured loans that you can take out to pay for specific expenditures, such as a vacation, a wedding, or a major appliance. The lender grants you credit based on your creditworthiness or, in some cases, on the creditworthiness of a co-signer (someone who agrees to repay the loan if you are unable to).
Because unsecured loans are riskier for lenders, most of these loans have higher interest rates than secured loans do. Due to high interest rates, particularly on credit cards, these loans can represent the biggest drain on your finances.
