Bank loans run the gamut from personal loans and credit cards to home loans, car loans and student loans. Despite their differing purposes and terms, each is either a secured or an unsecured loan with a fixed or variable interest rate. Understanding their similarities and differences can make it easier and less confusing to choose the right type of loan for your situation.
Secured loans are those backed by some form of collateral guarantee. With most secured loans, the item you’re purchasing is also the collateral guarantee. The bank maintains a legal interest in the collateral until you repay the loan. If you default on the loan payments, the bank has the right to repossess the collateral item or property.
Common examples are:
- Mortgages and home equity loans and lines of credit
- Car, truck, recreational vehicle, motorcycle and boat loans
Although less common, cash in a savings account or a certificate of deposit can serve as collateral for a personal loan or line of credit. The bank eliminates risk by lending only as much cash as you’re willing to pledge and by freezing the money until you repay the loan.
Secured loans tend to have lower interest rates and longer term lengths than unsecured loans because lenders usually consider them less risky.
Banks typically consider unsecured loans much riskier than secured loans. With no collateral to serve as a loan guarantee, banks rely solely on the strength of your promise to pay as evidenced by past credit performance and your current financial situation.
Common examples are:
- Personal loans and lines of credit
- Private student loans
- Credit cards
Unsecured loan interest rates are often significantly higher for borrowers with average to low credit scores. For example, an interest rate of about 30 percent is not uncommon for a credit score in the low 600-point range. In contrast, interest rates ranging from 8 percent to 10 percent are commonly associated with credit scores in the high 700-point range.
Based in Green Bay, Wisc., Jackie Lohrey has been writing professionally since 2009. In addition to writing web content and training manuals for small business clients and nonprofit organizations, including ERA Realtors and the Bay Area Humane Society, Lohrey also works as a finance data analyst for a global business outsourcing company.