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Are you thinking about taking out a personal loan? If so, you should understand that there are a variety of different loans to choose from. An important distinction you should understand is the difference between secured and unsecured loans. No matter how much you want or need to borrow money, you should first understand the difference between a secured and unsecured loan so you are fully informed about which loan is most appropriate for your circumstances.

What are secured personal loans?

A secured personal loan is popular when seeking funds for home renovations, commercial loans and other large investments, such as vehicles or boats.

With a secured personal loan, you are required to forfeit or “surrender” a valuable asset to the lender. This then becomes what it known as ‘loan collateral’, which is a means of ensuring the loan repayments are met and there is no default.

Loan collateral can include things like:

  • A certificate of title for a property;
  • Shares in a company; or
  • A valuable asset, like a vehicle, a boat, a piece of jewellery or a piece of artwork.

If you fail to meet your repayment obligations under the secured personal loan, the lender may enforce its security by seizing and selling the item that you have provided as collateral and using the sales proceeds to pay off the remainder of the loan. If the sales proceeds are insufficient to pay off the outstanding debt, you will still owe money to the lender.

What are unsecured personal loans?

Unsecured personal loans are popular amongst students for student loans, small business owners for small commercial debts, homeowners for minor domestic repair work and individuals needing small personal loans.

With an unsecured personal loan, you are not required to forfeit collateral to the lender. This means that if you fail to make repayments under the loan agreement, the lender has no security that it can enforce and therefore it cannot seize any of your assets to meet your repayment obligations.  Accordingly unsecured personal loans are a lot riskier for the lender and the lender will typically charge a higher interest rate on these types of loans than secured personal loans.

Should I use a guarantor for personal loans?

Regardless of whether you have a secured or unsecured loan you (or the lender) may also want to have a third party guarantee your loan repayments.  If the guarantor is someone with a high credit rating then it will give the lender greater certainty of repayment meaning they may charge you a lower interest rate.

If you fail to repay the lender, the lender will usually pursue you for the money before approaching the guarantor.  However, in some circumstances, the lender may chose to go after the guarantor first.  For example the lender may prefer to ask the guarantor for the money before enforcing the security (which can be a lengthy and complicated process).  This does not mean you can take out unsecured personal loans and rely on the guarantors to repay them. Once the guarantor has repaid the debt on your behalf, the guarantor has the same rights against you as the lender had against you, and can personally pursue you for the debt that they repaid on your behalf.

Conclusion

The rule of thumb, no matter what you need a personal loan for, is to borrow only what you have capacity to repay. Ask yourself: Can I service these loan repayments with my current income? If the answer is ‘no’, then you should reconsider the amount you are borrowing or the type of loan you are considering. It is a good idea to find a lawyer to review the terms of the loan agreement and any security documents, to ensure you are aware of your responsibilities prior to getting a loan.

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