Secured credit and unsecured credit are very different types of credit in terms of risk to consumers and lenders. According to a leading credit expert, you need to understand the benefits and drawbacks of each type of credit. because they can affect your credit score.
What Exactly Is Secured Credit?
Secured credit is a type of credit that is secured by a physical asset as collateral. If a borrower defaults on this type of loan, the lender may take possession of the collateral to recoup the loss. A good and common example is an auto loan. In an auto loan arrangement, the vehicle also serves as the collateral. The lender does not transfer the title until you complete payment.
The same goes for a mortgage: The home is the collateral for the home loan. In case of default, the loan is secured by your home, and the bank continues to “own” the home until you pay it off. In this case, failing to pay your mortgage may result in the bank foreclosing on your home, which means they will evict you and sell it to someone else.
Title loans and pawnshop loans are also examples of secured loans.
While the majority of credit cards are unsecured, secured credit cards are available for consumers who may be unable to qualify for unsecured credit cards due to poor credit or a lack of credit history. With a secured credit card, you make a security deposit that counts toward your credit limit and that the lender can keep if you are unable to make the required credit card payments.
What Exactly Is Unsecured Credit?
Unsecured credit is credit that does not have a physical asset as collateral, which means the lender cannot repossess an asset if you default on the debt.
Unsecured Credit Examples
A student loan is an example of an unsecured loan because there is no tangible asset that can be taken away if you do not repay your student loans. Student loans are used to pay for education, and the lender cannot, of course, “take back” the education you have already received.
Credit cards, with the exception of secured credit cards, are generally extensions of unsecured credit.
Your Credit Score and the Effects of Secured and Unsecured Debt
According to John, credit scoring models treat secured and unsecured accounts equally. Credit scores do not penalize or reward you based on whether your accounts are unsecured or secured.
Credit scores still treat different types of accounts differently due to other factors (for example, credit cards are treated differently than installment loans), but this factor does not play a role.
Use Secured Credit Cards With Caution
Consumers frequently use secured credit card accounts to establish credit or rebuild credit after having bad credit. This is an excellent credit-building strategy, but you should exercise caution when using your secured credit card.
Why? Because secured credit cards frequently have extremely low credit limits. That means that even with modest spending, you can quickly reach a high utilization ratio on the account. For example, if your secured credit card has a $500 credit limit and you have a $500 credit limit and you spend $250, you already have a 50% utilization ratio on that account.
Having heavily used credit card accounts can have a significant negative impact on your credit score, so if you want tscore, so if you want to keep your credit score as high as possible, you’ll want to keep an eye on your secured credit card balance and not let it creep too high relative to your credit limit.
Are “Buy Here Pay Here” Auto Loans Good for You?
When a person’s cash reserves are insufficient to cover the cost of a car purchase, many turn to auto loans. However, lenders who are financial institutions, such as banks, may check your credit report. This may cause concern if you have bad credit.
The good news is that BHPH (buy here, pay here) auto loans are now available. Through these loans, buyers with no credit or bad credit can obtain in-house financing from the dealership. However, it is critical to keep in mind that this type of auto financing comes at a hefty cost, possibly greater than the car’s actual value. Your interest rates will likely increase, and you may even be required to consent to be tracked.
Examining the Process
Purchase here and pay here Financing is a type of auto loan that is almost always used to purchase previously owned vehicles. This auto loan is provided directly by the dealership. This is distinct from when the dealership offers you a loan through a financial institution with which they have partnered, such as a local credit union. There, the dealership acts as a go-between for you and the credit union, saving you the trip. However, the dealership will almost certainly charge you a fee for loan processing.
On the other hand, a buy here, pay here loan is the car dealership’s own form of in-house financing. When you apply for a buy here, pay here auto loan, the dealership becomes your lienholder. They will determine your interest rate and payment schedule, the most common of which are biweekly or weekly payments.
The terms of the majority of loans are largely determined by your credit score. If you also have a higher credit score, your interest rate will be lower. This frequently results in a lower down payment. However, with buy here, pay here loans, there is no requirement for a credit check. This adds to the allure of these loans for those with poor credit. This, however, means that the auto dealer, who serves as the lender, in this case, will charge extremely high interest rates.
Down payments on vehicles purchased with BHPH loans may vary. They may charge extremely low or extremely high prices to entice customers. While the Federal Reserve regulates traditional lenders in terms of loan amounts, this is not the case with used car dealerships and lots. They may finance the vehicle for a higher price than it is worth, particularly if it is a pre-owned vehicle. Repossession benefits BHPH lots. They will repossess your vehicle if you fall behind on payments and resell it to buyers with poor credit.
Pros and Cons
Obtaining financing through buy here, pay here auto loans is significantly faster than the traditional loan process. This is because the dealership makes the decision immediately. As expected, the primary benefit of buy here, pay here auto loans is that they enable you to obtain financing for your vehicle that you may not be able to obtain elsewhere due to your low credit score. However, its primary disadvantage is its high price.
The Debt Snowball Plan & How to Use it to get out of Debt
Getting debt-free is never easy but something that many people want to accomplish. The typical approach that most people take when trying to pay off their debt is to try and pay off the debts with the most interest, or largest amounts, first. While, mathematically, this is a sound approach, it can often become frustrating and end in failure.
If you’ve struggled to stay consistent in your efforts to pay off your debt, you may want to consider using the Debt Snowball Plan. This approach has been shown to be effective as a means to pay off debt without losing momentum or leading to frustration.
How the Snowball Plan Works
When paying off your debt, rather than attempting to pay off the largest amounts first, you should first tackle the smaller debts. By paying off the smaller debts first, you will quickly see progress as you pay off the smaller amounts faster which will help encourage you to continue with your goals.
To start, make a list of all of your debts (minus your mortgage) and list them from highest amount to lowest. Next, each month make the minimum payment necessary for each debt except the very lowest. With your smallest debt amount, pay more than the minimum payment – as much as you can. Once you’ve paid off your smallest debt amount, take what you were paying on that debt and apply it to the monthly payment of your next largest debt amount while continuing to pay only the minimum on all other debts.
An example of this method could look like this:
- Credit card 1: $500 at 14% with a monthly payment of $25.
- Credit card 2: $1,000 at 18% with a monthly payment of $50
- Car loan: $6,000 at 5% over 4 years with a monthly payment of $135.
- Student loan: $15,000 at 5% over 10 years with a monthly payment of $159.
Using the Debt Snowball Plan, you would pay the minimum amount on each of your debts but by adding an extra $100 to your smallest credit card payment, you would pay it off in 4 months. Next, you would apply the $125 you were paying on the smallest credit card payment to the second credit card to a total of $175 per month. The second card will then be paid off in 5 months. Once the second card is paid off you can add the $175 to the car payment of $135 for a total of $310 to put toward your monthly car payment – paying it off in 15 months.
Continuing with this method on your student loans and you’ll be debt-free in just another 24 months’ time. This method will help you keep the momentum going and prevent you from becoming discouraged along the way.
For additional credit counseling and credit repair help, please call: (480) 478-4304
Explained: Home Equity Line of Credit
As housing prices continue to rise homeowners are looking into how they can leverage their home’s equity to receive low-interest financing. A home equity line of credit, or HELOC, is a great way to gain access to a line of credit based on a percentage of your home’s value, less the amount you still own on your mortgage.
The downsides are that if get yourself into a situation where you cannot repay your HELOC, the lender may force you to sell your home in order to settle the debt.
How a HELOC Works
Let’s say your home has an appraisal value of $400,000 and you have a remaining balance of $200,000 on your home’s mortgage. A lender typically allows access to up to 85% of your home’s total equity.
(Value X Lender Access) – Amount Owed = Line of Credit
$400,000 X 0.85 = $340,000
$340,000 – $200,000 = $140,000
Unlike home equity loans, your home equity line of credit will have a variable rate, meaning that your interest rate can go up and down over time. Your lender will determine your rate by taking the index rate and adding a markup, depending on the health of your credit profile.
When a HELOC Makes Sense
Your home equity line of credit is best used for wealth-building uses such as home upgrades and repairs, but may also be used for things like debt consolidation, or the cost of sending your kid off to college. While it may be tempting to use your HELOC for all sorts of things, such as a new car, a vacation, or other splurges, these don’t do anything to help improve your home’s value. To ensure that you will be able to pay back your loan, it’s important to focus on wealth-building attributes where you can.
Home Equity Line of Credit vs. Home Equity Loan
If you’re exploring various lending options, you’ve probably come across two different home lending terms, home equity line of credit and home equity loan.
While home equity loans give you all the flexibility and benefits of tapping into the value of your home when you need it, a home equity loan offers a lump-sum payment.
Depending on your situation, a lump-sum withdrawal may be better suited for your needs. Understanding the differences is the first step in making a loan decision that is best for you.
• Home Equity Loan (HEL) – A home equity loan lets you borrow a fixed amount in one lump sum, secured by the equity of your home. The loan amount you will qualify for will depend on your Loan to Value ratio, credit history, verifiable income, and payment term. These types of loans have a fixed interest rate, which is often 100% deductible on your taxes.
• Home Equity Line of Credit (HELOC) – A home equity line of credit is not so much a loan, but a revolving credit line permitting you to borrow money as you need it with your home as collateral. Applicants are typically approved based on a percentage of their home’s appraised value and then subtracting the balance owed on your existing mortgage. Things like credit history, debts, and income are also considered. Plans may or may not have regulations on minimum withdrawals and balances, as well as a variable interest rate.
Before tapping into your home’s equity, it’s important to weigh the pros and cons of each type of loan for your situation. Because your home equity line of credit and loan involves your most important asset – your home – the decision should be considered carefully. Is a second mortgage better than a credit card or a secured loan? If you’re not 100% sure, talk to a finance specialist before putting your home at risk.
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