The following is a guest post. Enjoy!
Many people right now are in a situation where money is tight. There are many people who live paycheck to paycheck who are simply unable to build up their savings. Some are barely unable to make ends meet, or they simply lack the financial literacy to make effective use of their money.
Living paycheck to paycheck, without a financial buffer, is pretty much like walking on a tightrope. The smallest misstep or bad luck could put you in dire financial straits with no good choices to get out of it.
Besides the best contingency plans, you can also consider taking out a loan. Loans can be a godsend for both the people who have no money, as is the case with an emergency.
But loans can also be double-edged swords. While they can get you out of a tight spot now, they may cause you to lose something of much greater value later on if you aren’t careful with how you handle loans.
The types of loans you can get play a heavy role in risk management both for you and the lender. A few factors to help you determine the type of loan you plan on getting are the following:
Collateral
The defining difference that sets secured loans from unsecured loans is protection. Secured loans involve property or equipment to be used as collateral, which the lender gains ownership of if the borrower defaults on his payments.
On the other hand, an unsecured loan does not require collateral from the borrower. You can then infer that secured loans are risky for borrowers and low risk for lenders, while the opposite is true for unsecured loans. This risk factor also influences the other loan aspects significantly.
Lien Usage
A lien refers to the right to keep possession of a property of a borrower until his debts are fully paid. As previously mentioned, secured loans require collateral while unsecured loans do not. A prime example of a lien is when car title loans are taken out, the borrower must leave his car’s pink slip with the lender until he is able to pay off the loan.
Interest Rate
The risk level of borrowers plays a big role in determining interest rates. Lenders affix high-risk loans with higher interest rates and lower interest rates for secured loans. Through higher interest rates, lenders are able to break even with the transaction.
Loan Amount
Borrowers who take out secured loans are able to get a significantly higher loan amount than borrowers who take out unsecured loans. Again, the key factor here is security. Lenders are more willing to lend a bigger amount because they’re confident that the buyer has every reason to make sure that payments are on time.
When a borrower defaults on payments in a secured loan, lenders are at least able to get something of value in lieu of money. When a buyer defaults on an unsecured loan, lenders are left with nothing, and thus they lose the money that was loaned. It’s pretty much like putting your trust in another person. You’re more likely to share more of yourself with a person you trust versus a stranger.
