What are the different types of loans?

People borrow money for a variety of reasons. It could be expanding their business, funding higher education, buying a house or a car, buying a ring for their girlfriend or wife.

Loans generally fall into two categories, secured and unsecured. Let’s first understand what a secured loan is.

Secured loans are those for which a borrower keeps an asset as collateral or collateral to borrow money. The collateral can be your car, your house, or anything of value.

It just means that in the event of default, the lender can use the asset to repay the funds it has advanced to the borrower.

Common types of secured loans are mortgages and auto loans, in which the financed item becomes the collateral for the financing. With a car loan, if the borrower is in default, the credit issuer can seize the vehicle.

When an individual or business takes out a mortgage, the property in question is used to secure the repayment terms. In effect, the lending institution maintains the equity in the property until the mortgage is paid in full. If the borrower defaults on the payments, the lender can foreclose the property and sell it to collect the funds owed.

Now let’s talk about unsecured loans. Unlike secured loans, unsecured loans are taken out without keeping any collateral. If the borrower defaults on this type of debt, the lender takes legal action to collect what is owed. Lenders give funds in the form of unsecured loan only based on the creditworthiness of the borrower and promise to repay.

Banks charge a higher rate of interest on unsecured loans because they are high risk. In addition, the credit score and debt-to-income ratio requirements are generally more stringent for these types of loans.

While giving unsecured loans, banks check the credit history of the borrower. Any past default may result in the cancellation of the loan. Apart from this, the financial position of the borrower is also checked as to whether he will be able to repay the loan.

Examples of unsecured loans are personal loans, student loans, and credit card transactions. And when a bank finds that a loan or unpaid amount is no longer collectible, it is considered a bad loan.

The RBI recently said in a response from RTI that banks had written off a whopping Rs 1,168,095 crore in bad loans over the past 10 years. Apparently most of them were unsecured loans.

People who do not want to pledge their assets or have no property to apply for a secured loan, opt for the unsecured loan. This is a good option if you are looking for immediate cash flow.

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