Secured Loans and your Credit

Secured loans are loans where the borrower must put up collateral in exchange for receiving the loan. The most common types of secured loans are mortgages (where the house or property being purchased is the collateral) and car loans (where the car being purchased is the collateral). By contrast, unsecured loans are loans where the borrower is not required to put up collateral to receive the loan. With secured loans, the lender holds the deed or title to the collateral until the loan is paid in full. While houses and cars are the most common types of collateral, stocks and bonds can sometimes be used as collateral too.

Advantages of Secured Loans

Secured loans have certain advantages over unsecured loans:

• Interest rates are often lower than rates on unsecured loans
• They allow people with average incomes to purchase things it would be difficult to save enough cash for
• The loan process has checks and balances to help buyers avoid making unwise purchases (such as requiring termite and structural inspections on houses)

Disadvantages of Secured Loans

The primary disadvantage of unsecured loans is that if the borrower defaults on the loan (stops making payments), the collateral will be seized by the lender to make up for the lost loan payments. People with secured loans should make monthly loan payments a top priority to avoid losing their home or source of transportation.

Secured Loans for Managing Debt

During the early 2000s, millions of people used secured loans against their homes to pay down high-interest debt (often credit card debt) at much lower interest rates than credit card interest rates. While this strategy worked during the years when housing prices boomed, it backfired once housing prices dropped in 2008. People still use secured loans to pay down credit card debt, but the practice is seen as riskier now due to instability in home prices. Hundreds of thousands of people found that they owed more than their homes were worth once housing prices collapsed, leaving them with big debts and drastically raising the risk of foreclosure.

Alternatives to Secured Loans for Managing Debt

Fortunately, other options exist besides secured loans for dealing with high debt loads:

• The DIY approach of cutting up credit cards and applying all extra income to paying credit card balances
• Credit counseling, which helps people develop a budget and a plan for paying off creditors
• Credit consolidation loans, which can roll multiple debts into one loan with a lower interest rate than credit card rates
• Debt settlement plans, which involve negotiating with creditors to lower interest rates or write off part of a loan in exchange for a lump sum in cash
• Debt management plans, in which consumers pay a flat monthly fee to a credit counseling service that negotiates better terms with creditors and distributes monthly payments on behalf of consumers

Secured loans for paying down debt should only be taken after careful consideration of the risks. While unsecured loans have higher interest rates, the risk of losing a home or car is far lower than with secured loans. In general, a person who wants to take out a loan to pay off credit card debt should pursue an unsecured loan first, and only take a secured loan if turned down for unsecured credit.

Sources:

http://www.beatmydebt.com/news-articles/important-debt-management-plan-questions-answered.htm http://www.wisegeek.com/what-are-secured-loans.htm http://www.omniglot.com/onlineinfo/delaware/secured-loans.html