Interest Rate And Collateral Implications

Everybody knows that secured loans imply lower interest rates than unsecured ones. However, the implications of collateral on loans go far beyond than that. So if you are interested on obtaining financing with advantageous terms, you should understand how collateral can affect the interest rate and other terms of loans and lines of credit. Following is a brief explanation of how collateral affects these variables.

Different Secured Loans On The Market

Though the classic secured loan is the mortgage home loan, there are other secured loans available on the market: home equity loans use the available equity on your property to secure the loan; certain car loans use the car as collateral for the loan, trading in any type of object for cash constitutes also a secured loan. Commercial loans let you use many different assets as collateral like, company's revenues, real estate, credit card payments, etc.

As you can see, there are many types of loans that use assets as security to guarantee the loan repayment. All share the characteristic of secured loans that allows the lender to seize either the property or the right to collect from its sell the amount of money owed. This is what makes these loans less risky for lenders and provides the borrower with a cheaper source of funds in terms of interests.

Does It Really Make Such A Difference?

Let us think a minute about the interest rate charged on a regular mortgage loan. This rate can vary but the average rate is 7% and only extreme situations can reduce it or raise more than a point or two below or above that rate. On the other hand, the interest rate on unsecured personal loans or lines of credit can reach up to 20%, 30% or even more depending on the type of financial product you are applying for and your credit score or history.

As you can see, the lack of collateral on a loan can imply up to 3 times more money spent on interests. The answer to the above question is thus inevitable: YES it does! However, this does not mean that it is always advisable to apply for secured loans. The decision is a matter of risk management and opportunity. Moreover, there are certain situations where unsecured loans or lines of credit charge lower rates for specific and limited periods of time.

What Do I Base My Decision In?

You may wonder then, if the rates are usually higher but sometimes equal or lower, if the risk is higher but the lender can still take legal action, what should you choose as a source of funds? We always suggest, whenever possible, to apply for a secured form of financing. If you take the proper precautions, you will not have problems with repayment. If you are certain that you will be able to afford the monthly payments, even if something unexpected happens and you need to make some sacrifices, you should apply with the aid of collateral. And if you are not sure as to whether you will be able to repay the loan, then, you should not be applying for one at all regardless of whether it is secured or unsecured!