Secured or Unsecured Loans - Which Is Your Poison?

At some time in life, nearly everyone will need to borrow money. Rare is the person who has saved enough to buy a car, appliances and other necessities of life when the need arises. In these circumstances, most people obtain a consumer loan.

Secured loans involve collateral or something of value that the lender can claim if the borrower cannot repay the loan. Collateral defrays the monies lost by the lender if the borrower is unable to fulfill the contract of the loan.

For instance, if you borrow money to remodel your home then the house is usually the collateral for your loan. If you renege on a loan you took on a car, the lender will be able to repossess the car.

Unsecured loans do not use collateral as a basis. When you qualify for an unsecured loan, the lender has reason to believe that you can and will fulfill the contract between you. Credit cards are frequently unsecured contracts. These type of loans typically have higher interest and lower credit limits than secured loans.

Interest is an important consideration in choosing your loan type and lender. Simply put, the interest is the lender's way of making a profit on the loan.

Interest is a percentage of the loan that is added to the principal (the original amount you borrowed). The amount of interest will vary with each lender. The interest rate on a car loan, for example, could make the difference between a payment of $391 per month (5% rate) and $448 per month (12%).

Many car dealers have their own financing company that charge higher rates than a bank or credit union, so shopping around for your loan is very important.

Before granting a loan the lender will be sure that the borrower has good credit, or a record of paying bills on time or paying off other loans without incident.

The better your credit, the more willing lenders are to make loans. Interest rates are lower, too, when borrowers have good credit records. The lender will then calculate your debt-to-income ratio, or how much of your income is spent on paying back other loans as well as personal living expenses such at a mortgage.

The general debt-to-income ratio is 38-40%. For example, if Jack makes $3000 per month and his mortgage and other expenses total more than $1200 per month the lender will assume that he has all the debt he can presently handle and will refuse to make the loan.

Before applying for any kind of loan, it's vital that you know your credit score (you can obtain a free credit report once per years from the three major credit reporting services).

While the banking and loan industry generally have fair and ethical standards, there are instances where you may be told your credit isn't good enough to qualify you for a lower interest rate. If you are aware of your credit score you will be able to correct their mistake and get a better interest rate or a higher credit limit - or take your business to a more scrupulous lender!

Consumers should always read contracts thoroughly, as they often include agreements to add items such as credit insurance to your monthly payments. If you do not want such insurance from the lender (you can usually get it cheaper elsewhere) you'll still pay for it if you sign the contract without reading it carefully.

It is your right to take as much time as you need to know exactly what you are signing! The lending agent that tries to rush you through a contract must be told in no uncertain terms that you need to be sure what you are signing.