The personal loan space is booming.
New lenders are coming on-line seemingly every day. There is peer-to-peer, standard, online, brick-and-mortar, credit unions, even one company that allows you to leverage friends who are willing to "vouch" on your behalf.
According to the most recent data from Transunion, U.S. companies lent in the third quarter of 2015 a total of $82.52 billion in unsecured loans and $165.46 billion in secured loans.
But what's right loan for you? A good place to start is understanding the different types of debt.
The difference between secured and unsecured debt
There are two basic types of personal loans, which incur two different types of debt. Which type of loan you choose depends on what you are trying to finance.
Secured loans are those that are backed by an asset. The asset is called collateral. Typically, these
If you default on a secured loan, the lender can take the property to which the loan is attached. This is called a repossession. If the collateral is determined to be worth less than what remains on the loan, then you could still be liable to pay back the remainder. This is what happened during the Great Recession that began in 2007. Many of the mortgages that were defaulted were worth more than the house.
With an unsecured loan, there is no collateral attached to the money. The most common type of unsecured debt is credit card debt. Other types are student loan debt, medical bills and child support. Typically, unsecured loans charge higher interest rates than secured loans. When these loans are defaulted on, there is no collateral for the lender to repossess.
In the case of a defaulted unsecured loan, the lender can:
- Hire a debt collector to pursue repayment
- Seek to garnish your wages (meaning that a percentage of your paycheck will automatically go the lender until the debt is repaid)
- Report the default to credit bureaus, thereby damaging your credit score for future loans
- Put a lien on other assets you have
How to decide between secured and unsecured debt
This mainly comes down to a question of amount, and your ability and willingness to put up collateral.
In many cases offering an asset to back your loan can lower your interest rate, extend your terms and allow you to borrow more, but unsecured loans won't risk your home if something goes wrong.
Examples of each type of loan:
- home equity loan
- auto loan
- home equity line of credit
- fun stuff: boats, RVs
- personal loans
- credit cards
- student loans
There are more alternatives to debt, including consolidation and negotiating with your creditors.