By Gary, on July 29th, 2012
Back in March of 2012 I posted a blog that talked about loans, specifically the difference between Revolving Loans and Installment Loans.
With that, let’s talk about the difference between an Unsecured Loan and a Secured Loan.
An Unsecured Loan is money you borrow from a bank or creditor that is only secured by your good promise to pay it back. You agree to the terms of the loan, usually printed quite small on the back of your monthly statements. You also agree to their interest rates, minimum payments schedule and penalty clauses. In other words, to have an unsecured loan, you will have to agree their terms and a higher interest rate. These types of loans are fairly recent in the history of loan making. Not more than fifty years ago, banks required collateral in order to loan you money. This type of loan would be a secured loan.
A Secured Loan is money you borrow from a bank or a creditor that is backed by a portion of an asset that is yours. An example would be that if you needed five hundred dollars and you had money in savings to cover that amount, the bank would loan you the five hundred but use the money in your savings account as the security they would need should you would default on the loan. Another example would be if you wanted to buy a home or a car, you ask the bank for the loan and they would loan you a portion of the value of the home or car but keep the title(s) until you paid off the loan, thus the home or car is the collateral for the secured loan. Once you pay the loan off they would release the title to the property and send it to you.
What happens when you default?
When you default on an Unsecured Loan, the banks or creditors get real nervous and begin using some or all of these tactics to get you to resume paying them: raise your monthly interest rate; charge a penalty, start calling you, send you past due letters, turn your account over to a collection agency; and, if necessary, file in court for a judgment against you. This can be very messy. Sometimes you can negotiate partial settlement, but be aware that the creditors, by law, can send you a 1099 form at the end of the year and you will have to include the difference between what you owed and the settlement as ordinary income on your tax return. There are state laws that slightly protect the borrower from being harassed by the creditor, but most laws are written to benefit the creditors.
Defaulting on a Secured Loan is different, or is it? Back when home values were going up, defaulting on a secure loan triggered foreclosure on the property where the bank takes your home, forgives your loan, you move out and find somewhere else to live. Now that home values are not going up, you need to check your loan documents for a “recourse” clause. This clause allows the bank or creditor to not only foreclose and take possession of the property but to also come back at you to pay the difference between the loan and what they can sell the property for plus any expenses to get the property ready to sell. This amount can then actually become an Unsecured Loan because it not backed by any asset.
Be aware that banks run the show and that law makers are prone to help them and not you. Take the time to read and understand your loan documents. They are, in fact, a contract or binding agreement between you and the bank or creditor.
“If you need to default on a loan for any purpose, it is to your benefit to contact the bank or creditor to work out a mutually beneficial plan.” This statement does not necessarily work in this current economic climate. But you should try it just the same.