Secured Loans Vs Unsecured Loans

The difference between secured and unsecured loans is important for corporates as well as consumers since both require loans albeit for different reasons. In other words, loans can be availed for tending to commercial as well as personal needs. Depending upon the terms and conditions of the lender, commercial and personal loans may be further classified as secured or unsecured. The following write-up examines the differences between secured loans vs unsecured loans by delving into the details of the same.

Secured Loans Vs Unsecured Loans

The difference between secured and unsecured loans can be best understood by examining the collateral, the maturity period of the loan, the amount that can be borrowed and the rate of interest on the loan. So, here goes...

Presence or Absence of Collateral

Secured Loans: Secured loans require the borrower to pledge some asset so that the disburser has the option of seizing the asset in case the borrower does not repay the principal and/or interest on the loan. Secured loans may be commercial or personal.

A commercial secured loan is procured by a business by using its assets as collateral. Businesses use fixed assets which are integral to the process of production to meet long term capital requirements. Short term loans are procured by companies by pledging current assets. Unlike fixed assets, current assets can be converted to cash within one accounting year. Hence, they can be used only to procure loans for meeting working capital requirements.

As far as secured personal loans are concerned, the borrower's CD (certificate of deposit) or savings account balance acts as the collateral for the loan.

Unsecured Loans: Unsecured commercial loans or unsecured business loans are administered on the basis of the creditworthiness of the business. In other words, the creditworthiness of the enterprise and its goodwill acts as a security for the lender. It goes without saying that only businesses of great repute can hope to avail these loans.

The borrower's credit score and credit worthiness are of immense significance when it comes to availing unsecured personal loans or signature loans.

Maturity Period, Amount Borrowed and Rate of Interest

Secured Loans: In case of a secured loan, the lender feels confident about his/her ability to recover the amount that is lent. The lender may be more amenable to agreeing on a longer maturity period and the borrower may also be able to negotiate a larger loan amount. The rate of interest on any loan is directly proportional to the risk encountered by the lender as a consequence of extending credit. The underlying collateral helps the borrower procure a loan at a reasonable rate of interest on account of less risk as perceived by the lender. Typically, most lenders allow businesses to borrow a secured loan for a period of 30 years with the loan amount ranging between $25,000 and $1,000,000.

In case of secured personal loans, the term of the loan is generally 10 years and the lender is willing to extend sums between $3,000 and $250,000. The rate of interest on a secured personal loan is fixed, thus eliminating uncertainty with regard to paying interest and principal.

Unsecured Loans: Unsecured commercial loans are best suited for companies that have been operational for a long period of time and have built-up quite a reputation for themselves. Goodwill and repute can go a long way in helping the firm avail a large amount of money, as loan, for an extended period of time without having to pay exorbitant interest. Small businesses that do not have a good credit rating and cannot provide the requisite collateral can at best avail a loan to the tune of $200,000.

Unsecured personal loans or signature loans may be availed for a maximum period of 5 years and one may borrow between $3,000 and $100,000. The interest charged on unsecured personal loans is higher than the interest charged on secured personal loans.

The above discussion does not advocate one form of borrowing or lending over another. The intention was to embark on a comparative study of secured loans vs unsecured loans so that prospective borrowers have a clear picture of the benefits and the disadvantages of various lending practices.