Secured and unsecured credit
About this video
The video explains the two major ways to borrow: secured and unsecured. Secured loans, like mortgages and car loans, are backed by collateral the lender can take if you don't pay, so they usually have lower interest rates. Unsecured credit, like most credit cards, has no collateral, so lenders take on more risk and charge higher rates; secured credit cards are a special case for building credit.
You'll be able to
- explain what makes a loan secured or unsecured.
- identify the collateral for a mortgage and a car loan.
- explain why unsecured credit usually has higher interest rates.
- describe what a secured credit card is and who it helps.
Key words
- secured loan
- A loan backed by something you own that the lender can take if you don't pay it back.
- unsecured loan
- A loan with nothing of yours backing it, so the lender relies on your promise and your credit.
- collateral
- The thing of value you provide that a lender can take or access if you don't pay back.
- down payment
- The part of a purchase price you pay up front with your own money instead of borrowing.
- repossession
- When a lender takes back the item, like a car, that secured the loan because payments weren't made.
- secured credit card
- A credit card backed by a deposit you give the issuer, often used to build credit.
Transcript
- When you borrow money or put another way, we could say, get credit or take on debt, there's really two ways, two major ways that that might happen. The first way is what's known as a secured debt or a secured loan. And the term secured is used because the person or the group that's lending you the money is securing it, they're protecting themselves by taking something or maybe being able to access something that you own in case you don't pay them back.
So typical examples of secured loans are, say, a home mortgage. You might need to borrow, say two or $300,000 in order to buy a house. Very few banks would just say, "Oh, here's two or $300,000, and if you're not able to pay that back, well, we'll just take the loss and mark your credit report down."
Most of them are going to want something of value that they can access, that they can take if you don't pay that money back. And for a home mortgage, it's going to be the house. The house is going to be that thing, that will be the collateral. So for example, we have other videos that go into a lot more detail here.
Let's say you put, you bought a $250,000 house, you have $50,000 down payment, you need to borrow $200,000. When you go to the bank, the bank says, "Okay, we'll lend you $200,000 at whatever interest rate based on your credit, et cetera. But if you become delinquent on that loan, if you do not pay that loan back, we are using your house as collateral."
Collateral is the thing of value you are providing that they can take or access if you don't pay back. So it is your house, but if you don't pay that loan back, it becomes the bank's house, it becomes our house. And then the bank will probably try to sell that house to get their money back.
Similarly, usually, a car loan is also a secured loan, the car itself would be the collateral. So if you're not able to pay that car loan back, you've probably heard of something called the repo man, repossession, repo is short for repossession, these are people who will come into your driveway into the middle of the night and tow that car back and take it to the bank and they'll probably auction it off or sell it in order to try to get back as much of the money that they lent you as possible.
So those are secured loans, they involve collateral. Now, on the other side of it, you have unsecured loans or just regular unsecured credit or unsecured debt. And the most common example of that is a credit card. When you use a credit card, you are borrowing money from that credit card issuer.
Now, if, let's say you take a credit card and you go on a shopping spree for a thousand dollars and you're not able to pay that thousand dollars back, they're not gonna come and take those clothes back, they don't even know necessarily where those clothes are.
They are going to ding your credit so there is an implication of not paying it back. You're gonna hurt your credit and, in the future, it's gonna be very hard for you to get credit, but it was unsecured. And so, the bank is taking on more risk in that situation, and because of that, they're gonna charge very likely a much higher interest rate than for a secured loan or for secured credit.
Now there, for folks, and so, in order to get that, you usually have to have pretty good credit to begin with and they're also gonna charge you higher interest. Now there are cases known as secured credit cards that involve you giving a deposit, and this is usually a case for someone who's trying to build credit who couldn't get an unsecured credit card.
And in that case, you might have a credit limit up into your deposit so that if you don't pay it back, the bank, the issuer, whoever it is, will be able to take that money back, but that's usually a special case to use to build your credit so that you can get unsecured loan and build a credit history.
But generally speaking, secured loans, especially things like cars and houses, lower interest rates because the banks can take that back, but you still need good credit in order to get that 'cause these are larger amounts of money. Unsecured credit, you need to have good credit to even get it to begin with and it usually has higher interest rates because the people lending you the money are taking on more risk.
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