All loans, no matter what they are, are either secured or unsecured.
Knowing the difference can better help you understand how they
work and what to expect when applying for one.
A secured loan is one that relies on an asset, such as a home or car, as
collateral for the loan. In the event of loan default, the lender can take
possession of the asset (foreclose on a home or repossess a car, for
example) and sell it to recover the amount of money loaned. For this
reason, interest rates for secured loans are often lower than those for
In many cases, such as in the purchase of a home, the asset to be used
as the collateral will need to be appraised before the terms of the loan can
Examples of secured loans are:
• Car loans
• Boat (and other recreational vehicle) loans
• Construction loans
• Home equity loans
• Home equity lines of credit
Unsecured loans do not require the borrower to put forth an asset for
collateral. The lender relies solely on the borrower’s credit history and
income to qualify him for the loan. If the borrower defaults, the lender
usually has to try to collect the unpaid balance through a variety of efforts
which may include using collection agencies, freezing accounts, lawsuits,
and garnishing wages.
Because there is a considerably higher assumption of risk on the lender’s
part with an unsecured loan, the interest rate is usually much higher.
They are often more difficult to obtain and the amounts loaned are usually
lower than that for secured loans.
Examples of Unsecured Loans are:
• Personal loans
• Personal lines of credit
• Student loans
• Credit cards/department store cards
Payday loans are relatively new on the loan scene. They are short-term
loans borrowed using the borrower’s next paycheck as guarantee for the
loan so, in a way, they are secured. However, payday loans have
notoriously high annual percentage rates (APRs) and can be difficult to
pay off. Banks do not generally offer Payday
loans. Most establishments offering them
are private companies with separate
A title loan, also fairly new, is a type of
secured loan where the borrower can use
their vehicle title as collateral. Borrowers
who get title loans must allow a lender to
place a lien on their car title, and temporarily surrender the hard copy of
their vehicle title, in exchange for a loan amount. When the loan is repaid,
the lien is removed and the car title is returned to its owner. If the
borrower defaults on their payments then the lender can repossess the
vehicle and sell it to repay the borrowers’ outstanding debt. Typically, the
same companies that offer Payday loans will also offer title loans.
Student loans are, of course, used to get a person through college or
other educational institution. There are many different types of student
Stafford loans, the most common federal education loans
students receive. They can be either subsidized or
Perkins loans, low-interest federal
loans, administered by the school, for
students who demonstrate
exceptional financial need.
PLUS loans, usually used to cover
expenses not met by other federal
financial aid. These can be taken out by dependent
students’ parents or by graduate students.
Institutional loans, non-federal aid that schools loan their
Private loans, usually sought by parents of students ineligible
for other aid or those who do not receive enough aid to cover
the cost of attendance. In many cases, these must be secured
by some form of collateral.
Mortgages are probably the most complicated types of loans and have the
most variations, the first being who is underwriting or guaranteeing the
loan. A mortgage loan might be any one of the following:
Conventional loans are those that aren’t insured by a government agency
like the Federal Housing Administration (FHA), Rural Housing Service
(RHS), or the Veterans Administration (VA). Conventional loans may be
conforming, meaning they follow the guidelines set forth by Fannie Mae
and Freddie Mac, or non-conforming, meaning they don’t meet Fannie and
FHA mortgage loans are insured by the government through mortgage
insurance that is funded into the loan. First-time home buyers are ideal
candidates for an FHA loan because the down payment requirements are
minimal and the borrower’s FICO credit score does not affect the interest
This type of government loan is available to veterans who have served in
the U.S. Armed Services and, in certain cases, to spouses of deceased
veterans. The main benefit to a VA loan is the borrower does not need a
down payment. The loan is guaranteed by the Department of Veteran
Affairs, but funded by a conventional lender.
Mortgage loans also vary greatly by repayment parameters. These days
there are many options including:
A fixed-rate mortgage is one in which the interest rate on the note
remains the same through the term of the loan. As a result, the payment
amount and the duration of the loan are fixed. The borrower makes a
consistent payment, usually monthly, for a specified number of years until
the loan is paid off. These payments are amortized, meaning that, as
time goes by, more of each payment is applied to the principal than to
The most common type of fixed-rate
mortgages are 30 year and 15 year but
other variations are also available.
An adjustable-rate mortgage, commonly
called an ARM, is one in which the interest
rate fluctuates. It can move up or down
monthly, semi-annually, or annually. In many types of ARM, the rate
remains fixed for a period of time before it adjusts. For example, the rate
on a 5-year ARM with a 30-year term will not be adjusted for the first five
With any ARM, it is important to note how frequently the interest rate can
adjust, plus the index and the margin used to set the new interest rate.
In other words, if it is tied to the prime rate and that rate jumps by 2
points in a year, the ARM rate could jump as well. However, there is often
a cap put on how much the rate can be raised in a single adjustment
Interest-only loans contain an option to make an interest-only payment.
The option is available only for a certain period of time. However, some
mortgages are indeed interest only and require a balloon payment,
consisting of the original loan balance at maturity.
These mortgages are structured with a payment schedule similar to that
of a thirty year fixed rate loan, although the term of the balloon loan is
shorter, most often spanning five to seven years. At the end of the loan
term, the outstanding balance must be paid in one lump sum, often by
refinancing the home.
Reverse mortgage are available to any person over the age of 62 who has
enough equity in their home. Instead of making monthly payments to the
lender, the lender makes monthly payments to the borrower for as long as
the borrower resides in the home (or it can be an up-front lump sum
payment). The interest rate can be fixed or adjustable. When the
homeowner moves out or passes, the house is sold and the mortgage is
Home Equity Loans
A home equity loan is a loan for a fixed amount of money that is secured
by a home. The borrower agrees to repay the loan with equal monthly
payments over a fixed term, just like the original mortgage. If the
borrower defaults on the payments, the lender can foreclose on the home.
A homeowner must have equity in the home to get a home equity loan,
thus the name. The equity is the appraised value of the home minus the
amount still owed on the original mortgage. Usually, the maximum loan is
for a certain percentage, say 90%, of the total value of the home minus
the amount of the original mortgage.
Home Equity Lines of Credit
Like a home equity loan, a home equity line of credit — commonly known
as a HELOC —requires the borrower to use his home as collateral for the
loan. The HELOC, however, works much differently. It is a revolving line
of credit, much like a credit card, against which the homeowner can
borrow by writing a check or using a check card connected to the account.
The credit can be used as needed, however, the total amount that can be
borrowed is set much like the Home Equity loan. Because a HELOC is a
line of credit, the borrower makes payments only on the amount actually
borrowed, not the full amount available, which can be an advantage for
many people. Also, even after paying down a HELOC, the homeowner can
re-borrow amounts up to the credit limit of the HELOC.