The Difference Between a Personal Loan and a Secured Loan

You may be asking yourself why the interest rate on a personal loan is so much higher than other types of loan such as for a mortgage or a car. That is simple to explain. When you take out an unsecured loan, the lending institution is taking a greater risk and you have to pay for that privilege.

Secured loan

A secured loan is not the same as a personal or payday loan. A secured loan is backed up by the property it is being used to purchase. For instance, if you were to take out a secured loan when you are buying a car, that loan is guaranteed by the vehicle you purchase. If you were to default on that loan, the bank would repossess your car and you would have to be responsible for the remainder of the loan after the car is sold at auction for whatever it would go for. This is the way lending institutions are able to prevent losing money, and there is less risk involved than would be present with a personal loan.

Unsecured loan

An unsecured personal loan is one that is given to clients without having collateral such as a house or car to guarantee it with. Since there is o personal property used to back it up with the loan will carry a greater risk for the lender. This is the reason a payday loan costs more for those who use them. To explain this, let’s say a borrower uses their home as equity when they take out a home equity loan for $ 15,000. The lender knows that the homeowner is not likely to default on this loan because they would lose their home if they did.

A personal loan is not as safe an investment for the lender, and because of this, the lender will charge a higher rate of interest as a means of balancing the risk verses the potential gain. Since a personal loan carries a higher risk, the lender has to make up for that risk by charging their customers more.

While most lenders understand that most people who take out a payday loan have every intention of paying them back in full, there comes a time when those who received money from such a loan are simply unable to return the money they borrowed plus the interest and that leaves the personal loan company holding an empty bag. The only alternative they have other than wrecking the credit rating of the individual is to charge everyone a high enough interest rate to recoup their losses.

As you can see, there are good reasons for charging higher interest rates on a personal loan, but this rate is still considerably lower than one would be able to get if they were to use a credit card for the money they need. If you don’t have the option of getting a secured loan but still need to borrow money, a personal loan may be a much better choice than using a credit card.