The differences between secured loans and an unsecured loans are simple to understand. A secured loan involves collateral, while an unsecured loan is based on a signature, or your word to repay it. There are positive and negative aspects to both, and a person can have multiple secured and unsecured loans at the same time.
Types of Secure Loans
A secured loan is based on collateral. Collateral is tangible property that the lender places a lien on when providing the loan to a borrower. An example would be a home or car loan. The home does belong to the owner, but the lending institution has a right to take and sell the home if the owner does not make his payments according to the terms of his loan.
There are many types of secured loans. A loan from pawnshop is an example. The owner of the pawn broker will give the owner of a diamond ring cash while keeping the ring as collateral. The owner of the ring will have a limited amount of time to pay any interest and the principle to the shop to get his ring back. Otherwise, the pawnshop has the right to sell the ring to another customer.
Common Types of Unsecured Loans
An unsecured loan does not have collateral attached. A balance on a credit card is an example. Due to the higher risk the lender assumes with an unsecured loan, the interest rate is usually higher than on a secured loan.
Lenders do have recourse in the event of non-payment of an unsecured loan. The borrower risks suffering damage to his credit rating, and the lender can take the borrower to court for nonpayment. Courts usually award judgments in favor of lenders.
Unsecured loans many times have shorter durations than secured loans. For example, personal unsecured loans through a lending institute, such as a bank, could be for a period of one month to a maximum of five years.
On the other hand, secured loans such as home mortgages can be for 30 years or more, while a new car loan can be for as long as seven years. The longer the duration, the less the borrower may pay per month, but the more interest the borrower will pay to the lender.
Income Tax Benefits
Secured loans, particularly home mortgages, have income-tax benefits. These benefits include the ability to deduct interest paid. Businesses may also be able to deduct interest paid on automobile and other types of loans as well.
Income Tax Considerations
Whether you have a secured loan or an unsecured loan, the principal is not taxable or tax deductible. Interest is considered income for the party being paid the interest, whether it is a secured loan or an unsecured loan. It should be reported as income on personal or business income taxes.
When you sell something, such as your home, you report the purchase price and the selling price. You may not deduct any interest you paid on the home loan because that interest was reported in earlier years.