Secured vs Unsecured Loans: What is Collateral?

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Have you ever wondered why, despite the huge sums of money involved, the interest rates of home loans almost always hover around 1% to 2%? Even more curious is this: how come personal loans and credit card bills carry much higher interest rates even though they involve relatively smaller amounts of money? The truth is that not all loans were created equal, and your mortgage is actually a secured loan, which uses your property as a collateral. In this article, we explain…

  • What's the difference between secured and unsecured loans?
  • Are home loans secured? 
  • What are the most common types of secured and unsecured loans?
  • What does my credit score have to do with anything? 

Related article: Guide to Mortgage and Housing Loans in Singapore (2020)

 

What's the Difference Between Secured and Unsecured Loans?

The main difference between secured and unsecured loans is what happens when you default on your loans. 

Secured loans are loans with an asset attached, which the lender has the right to take away if the borrower cannot repay the loan within a specific period of time. The asset, in this case, is also known as a ‘collateral’, and the loan is called a ‘secured loan’ because the collateral acts as a security or safety net for the lender. 

Your home loan is one such example: if you took a loan from a bank to finance your home, the home itself is the collateral. That said, seizure of collaterals is usually the last resort, and banks are more than willing to help defaulting borrowers with ample opportunities to make good on their debt — though not without additional fees that you have to pay.

Tip: Need help managing your home loan? Consider refinancing to save costs or speak to a Home Finance Advisor for advice. 

While this may seem intimidating, there are many advantages to secured loans. For instance, since there is collateral involved, lenders tend to offer a lower interest rate, a higher loan amount approval, and a longer loan tenure. That’s why you can borrow even a million dollars and take decades to pay off the debt at relatively low interest rates of around 2%.  

Unsecured loans, on the other hand, are loans that do not come with an asset attached. This means that if you somehow fail to repay the loans in time, you don’t actually stand to lose any assets. 

Now, before you presume that unsecured loans are far and away the better option between the two, there’s a catch: since there are no assets attached to unsecured loans, interest rates are naturally much higher than their secured counterpart. 

 

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What Are the Most Common Types of Secured and Unsecured Loans?

The most common types of secured loans are home loans and car loans. If you are taking out a HDB loan from the Housing Development Board or a bank of your choice, that is a form of secured loan. In this case, the property you are trying to finance is the collateral. 

The most common types of unsecured loans are credit cards, personal loans and student loans. 

 

How Your Credit Score Fits Into All of This  

A credit score is essentially a number that financial institutions consider before they decide whether to lend you money. The exact formula is not published, but your credit rating or score is generally based on a myriad of factors, such as your spending activity, how long you have been with a specific bank, how much credit you have, your annual salary, your length of employment, etc. 

After analysing all the data, each account holder is then assigned a credit score between 1,000 (the worst) and 2,000 (the best), which indicates how good (or bad) you are at repaying your loans. For more information, read our Credit Bureau Report Guide: Why a Good Credit Rating is Important for Your Home Loan.

If you default on your home loans – or a loan of any kind - your credit score will be affected. A poor credit rating may make it harder for you to apply for future loans, if need be. 

On a more positive note, keep in mind that your credit score is based on just the last 12 months of account repayment history, which means that it is in fact possible to rebuild from a bad credit score to a good one. 

If you have concerns about your home loan eligibility and are unsure if you’ll qualify for a mortgage, our Home Finance Advisors can help you look into it and provide personalised recommendations.  

 

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