What is a loan?
The Wikipedia definition says “a loan is an amount lent by an individual, organizations and other entities to individuals and organizations. The recipient needs to repay the loan amount over the decided period along with the interest that’s charged by the lender”.
When an amount is lent by someone, the lender is at risk until she/he receives the lent amount. There are chances that the borrower may not repay, to avoid such absurdity the lenders ask the borrower to pledge some asset as collateral. This asset reduces the risk of the lender and the lender can lend money without thinking twice.
There are two types of loans, a secured loan, and an unsecured loan.
What is collateral?
Collateral is an asset that an individual pledge while applying for a loan. It’s the guarantee that an individual gives to the lender about the repayment of the loan. It means if the individual fails to repay the amount then the lender can use the asset pledged by the individual to recover their money.
In case, if the collateral pledged by the individual doesn’t cover the total loan amount along with the interest then the lender has complete rights to obtain a deficiency judgment against the borrower and then the borrower must and should pay back the lender the remaining balance.
There are two types of collateral, tangible collateral and intangible collateral. Real estate, car, yacht, bike, etc comes under tangible collateral and bonds, shares, fixed deposit, etc comes under intangible assets.
How collateral benefits you while applying for a loan?
There are two ways of getting a loan. One is with the help of collateral and the other is without collateral. A loan that’s acquired with the help of collateral is a secured loan and the loan that’s acquired without the collateral is an unsecured loan.
The difference between secured and unsecured loans is the difference between the interest rate. A secured loan has knee-high interest rates and an unsecured loan has lofty interest rates. Unsecured loans have lofty interest rates because the lender is at very high risk while lending the money, as the risk increases, the interest rates start to take a vertical flight. Whereas, in the secured loan the lender is at no risk and hence they offer shallow interest rates.
Getting an unsecured loan is very difficult as banks reject 99% application of unsecured loans. The customers who have a very good credit score get approved. Only online lenders offer you unsecured loans, but at a lofty interest rate.
When a person pledges some collateral while applying for a loan, the person makes the loan safer for himself and the lender. You need to understand the fact that when you get an unsecured loan, you’re paying more due to lofty interest rates. These lofty interest rates are so heavy that if you do the calculations, you’re almost paying half the loan amount as interest. If you would have pledged collateral, you could have saved that half of the money and used it elsewhere.
Some online lenders offer better interest rates on secured loans than the bank. If you have collateral using it to get yourself a loan could save you from a lot of extra money that you would pay. Collateral also gives you an added advantage of getting a bigger loan and to re-build your credit score.
Getting a loan by pledging collateral could save you a ton of money. This will help build your finances and overcome debt, also bring in the discipline about the usage of money. For people who cannot pledge collateral, but they need a loan, research well and find the righteous lender that offers you maximum benefits on the loan. To avoid such instances, you should start by planning your finances, sub-divide your monthly income into parts that you can use for your needs and wants and a small portion for your savings. Read about how to manage your finances and get back on track.