Secured or unsecured loans: Which is the better investment?
When you begin P2P lending, you have the choice of investing in secured or unsecured loans. On face value, secured loans are lower risk, but unsecured loans generally offer better interest rates – and might even come with a risk mitigation measure such as a buy-back guarantee.
Today, we’ll explore the definitions of, differences between, and the relative plusses and minuses of secured and unsecured loans. With that knowledge behind you, your investing decisions should be a little easier.
Secured lending involves loans that require the borrower to provide collateral – an asset of value – to receive the loan. This means borrowers have something very real to lose if they don’t pay the loan back (also known as defaulting on the loan), while lenders have a tangible asset to liquidate and recoup their money.
Let’s take a look at a few examples of secured loans…
One of the most common secured loans, in this case, your collateral is the deposit and the property itself. While policies differ, it’s often four missed payments that will result in the lender coming to recoup their money. They do this through a legal process called foreclosure, which forces the sale of the house to cover the cost of the loan.
Borrowers can put their houses up as collateral for other loans, too. Whether you want to lend to them depends on how quickly you might need your money back. If they default, there’s a chance it could take months or even years to sell the collateralized property to repay you.
Car Title Loans
These loans require you to put up your vehicle as collateral. These loans are typically short (between 2 weeks and a month) and not for particularly high sums of money, as most loan companies will only lend up to 25% of the car’s value.
When you invest in a car title loan, recovering funds is a little easier since cars are easier to sell that property. However, given the depreciatory nature of vehicles, you might not get 100% of your principal back.
Borrowers looking for some quick cash can use their cryptocurrency as collateral to obtain a loan (such as through our platform). As people often treat cryptocurrency as an investment, this allows them to keep their crypto rather than selling it, and it’ll be returned to them after they repay.
Investing in crypto-backed loans can offer peace of mind. It’s a lot easier to get your money back if the borrower defaults as it’s much easier to liquidate crypto than say a house or car. Plus it’s arguably more ethical – you aren’t going to be turfing anyone out of their home or denying them their personal transport.
Unsecured loans don’t require collateral, so borrowers don’t need to stake an asset to secure one. This makes them riskier than secured loans, but they pay much higher rates of interest.
If you’re interested in investing in this type of loan, it’s important to understand risk and its relationship with reward. Generally speaking, the riskier the investment, the higher the reward, so you’ll need to decide how much risk you can tolerate.
With unsecured loans, one of the biggest indicators of risk is the credit score of the person you’re potentially lending to, or the solvency and financials of the business (if you’re lending to a business). A person’s credit score measures their financial trustworthiness.
The most commonly used credit referencing system is FICO, which determines your score based on things like your average income and expenditure, past debt (or lack of), how quickly you paid off that debt, as well as other factors like your housing situation. They then provide you with a score that represents how likely you are to make the payments on time. It gets simpler here, as higher scores are more desirable for both borrowers and lenders; the former will pay less interest on a loan than a riskier candidate, and the latter is more likely to get their money back.
As an investor, looking at the credit score of the potential borrower is important when you’re evaluating risk but it’s not the only way to mitigate risk when it comes to unsecured personal loans. You can also review the past default rates of the platform you’re thinking of using, as well as checking for any financial guarantees it offers if the borrower defaults.
Which is the better investment?
Well, the choice is ultimately up to you. With unsecured loans, there is certainly a balance between risk and reward. You can receive a much higher interest rate (even 30% or more) by lending to borrowers with bad credit scores, but there’s a high risk they won’t be able to make the repayments and you’d have to wait a long time to recoup even your initial investment.
Secured lending, on the other hand, is a safer option. If you choose to back cryptocurrency loans, you can sleep easy knowing there is something that can be sold off quickly if repayments can’t be met. Your personal appetite for risk is going to be a big factor in your decision, and we suggest that you read as much as you can before you make the decision.
As you can see, there are compelling reasons to invest in secured and unsecured lending. A little bit of diversification can help you find the right balance between risk and reward, and one of the easiest places to find that is with Loan Originator. This will allow you to pick and choose between a huge variety of loans, and the kicker is they all have a buy-back guarantee from the loan originator, so your chances of getting your money back if borrowers default are higher. Find out more about Loan Originator.
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