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Secured vs unsecured vs payday loans: Which one is right for me?

Before you take out a loan, here's what you need to know. (Source: Getty)
Before you take out a loan, here's what you need to know. (Source: Getty)

If you need to get a loan, now's the time to do it, with interest rates at an all-time low.

But even if you do decide to take out a loan, you’re faced with the next question: which kind?

Here’s a low-down from comparison site Finder on the different kinds of loans, what situations to pick them, and the pros and cons of each so you can pick the right one for you.

Secured loan

A secured loan is when you have to provide an asset, such as a car, as a guarantee.

It means that if you’re unable to make repayments, the lender can take possession of that asset and sell it to cover the loan cost.

Secured loans are less risky to lenders, meaning lower interest rates for the borrower. Secure loans are generally meant for those who have been denied unsecured loans, according to The Balance.

Pros

  • Lower rate because the loans are less risky for the lender

  • More flexibility in what you purchase with the loan. Unlike car loans, you can purchase whatever you need

  • Offering an asset can help your chances of being approved

  • A good way to build your credit score and credit history when used correctly

Cons

  • You can risk losing your asset if you default on the loan

  • When you attach your asset to a secured loan it needs to be valued. This value will then be used to determine the loan amount you are offered by the amount

Unsecured loans

An unsecured loan allows you to borrow money without providing any security. Such loans can be used for a range of things, such as paying for a holiday or making improvements to your home. You’ll typically need a higher credit score to be approved for some unsecured loans.

Pros

  • You can use the loan amount for any worthwhile purpose

  • Many banks and lenders offer their own version of an unsecured loan, so there are lots or options to choose from

Cons

  • They usually attract higher fees, penalty fees and interest rates than secured loans because there’s no asset put up as security

Payday loans

Payday loans are small, short term loans that are usually less than $2,000 but can be as much as $5,000. As the name suggests, payday loans indicate you will be able to cover the cost of the loan with future income.

You might want to use these loans for sudden emergencies, such as a medical bill, car repair or other one-off expense you need to pay.

But tread carefully: these loans are riskier for the borrower as they have higher fees and are known to be offered by disreputable lenders, Finder said.

For instance, taking out a $1,500 payday loan over a 12-month loan term would end up costing you $2,520 in total after the establishment fee of $300 and account-keeping fee of $60 per month were factored in.

That $2,520 in total is the equivalent of 68 per cent interest, according to RateCity.

Pros

  • You’ll get access to the cash quite quickly, sometimes within a few hours

Cons

  • Payday loans attract much higher fees and interest rate than personal loans. It’s important to decide whether you really need a loan before applying

  • They can attract disreputable lenders, especially online. Be careful when comparing and applying for loans. A reputable lender will never charge an upfront fee to process a loan application

  • Because the credit is unlocked so quickly, it can be a slippery slope and cause a payday loan spiral, in which borrowers are trapped in a cycle of loans, where repaying one loan leaves you short by so much that you have to take out another loan to cover regular expenses.

The inaugural Yahoo Finance All Markets Summit will be held on the 26th of September 2019 in the Shangri-La, Sydney. Check out the full line-up of speakers and agenda for this groundbreaking event here and buy tickets here.

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