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Debt Consolidation Financing - Pros & Cons of Secured and Unsecured Loans

Aug 18, 2007
Both the lender and borrower are faced at the outset with a basic decision, to either obtain or provide a loan that is either secured or unsecured, however what does that mean, and what are the pros and cons for the borrower and lender?

Pros & Cons of Secured and Unsecured Loans.

A secured loan is one in which the money borrowed is guaranteed to be repaid or some asset will be forfeited by the borrower. A common example is a home or property loan, the borrower agrees to repay on the contract terms, and if theory default, the lender can legally claim the home or property as compensation. In theory, this means that if you miss a payment on the home or property loan, the lender has the legal right to foreclose and sell the property or home. In practice, this rarely happens, as among other reasons, lenders know that reclaiming a house or property is a long and unpleasant practice and they would be left with the necessity to sell the home or property to recoup their money.

The majority of lenders are not going to do that for such a small misstep, as missing a single payment, even when the borrower lags by several months and payments, normally at most the lender will typically send a series of firm letters of demand, demanding payment before taking any further action. Even in an active and robust seller's market lenders have many more important actions and projects to do and don not want to undertake the effort of removing a homeowner and selling a house.

However, it is smart to realize that the lender has this legal right, how important or not that right is can be judged by recognizing that even with an unsecured loan, creditors have the legal right to seize assets like salaries, wages, stocks, bonds and other property. This action requires only undertaking a relatively easy and inexpensive legal procedure to declare the borrower in default, but, legal procedures are only relatively simple and inexpensive and lenders will almost always try to negotiate a repayment option before taking that final step.

There are many other differences between secured and unsecured loans that borrowers should be aware of, since the money in an unsecured loan is not, in theory, backed by the right to seize the asset in case of default, the interest rates on unsecured loans are normally much higher as the lender is taking a larger risk, and they are compensated by charging higher interest rates on unsecured loans, which covers their losses from defaults, which are normally higher on unsecured loans and is one way to change borrowers incentives not to default. Most people will try much harder to meet a debt that is tied to their home or other asset than for an unsecured loan.

So, there are many pros and cons for both the borrower and lender when obtaining or providing one type of loan versus the other, as the borrower, you may find it necessary to incur a higher rate of interest if you don't have a home, bonds or other assets to offer as collateral, or you may simply not want to put those assets at risk. Importantly only you can decide in your particular circumstances whether the advantages outweigh the risks and additional costs and interest.
About the Author
Ian Wilkie is a published author of many Debt Consolidation Financing articles and owner of - My Debt Consolidation Solution your one-stop online resource for Debt Help.
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