The media talks about mortgage rates constantly, and you’ve likely heard a lot about car loans, too. What do those two loans have in common? They are both referred to as “secured” loans because they are lent against–or “secured”–items (or assets) that the person borrowing the money is purchasing. These items are called “collateral.”
By contrast, a payday loan is an “unsecured” personal loan. In other words, when a lender gives you money for a payday loan, there is no specific valuable item that the lender is providing you money to purchase. Instead, the lender underwrites your ability to pay back the loan based on your income and a few other factors.
What is collateral, then, and why does it matter?
What is collateral?
When you’re borrowing money to buy a car or house, the bank has an ownership interest–called a “lien”–against the item that you’re buying. The asset that the bank lends against, be that a car or home, is called collateral. Collateral is, in essence, a valuable thing that the bank can take possession of and re-sell if the borrower stops paying his or her loan.
At its core, collateral gives lenders much greater certainty that they will be able to get their money back if you stop paying your loan. Lenders spend a lot of time underwriting borrowers for secured loans involving cars and homes, but they also spend a lot of time underwriting the item against which money will be lent. Lenders need to make sure that the car or home is worth what is being paid for them. Collateral provides extra security for the lender in case you stop paying your loan.
For example, say a borrower is paying $200,000 for a home and borrowing $160,000 to buy that home. The bank will order an appraisal to get an opinion of value that shows the bank that the home is actually worth $200,000. If buying a used car, a lender will consult a valuation service such as Kelley Blue Book to determine the value of the car being purchased.
Why does this matter?
Collateral is something that a lender can foreclose on–or repossess, in the case of a car–if the borrower stops paying their loan. This provides the lender with more comfort and security that they will be able to get their money back on the loan whether or not the borrower keeps paying the normal schedule of principal and interest. Why is this?
Imagine that a bank lends someone $10,000 to buy a used car. If a borrower stops paying the loan schedule and still owes $8,000 but the car is worth $8,500, the lender can repossess the car, sell it for $8,500 and make most, if not all, of its money back on the loan after selling costs. No one likes the repo man, but he’s there for a good reason: the bank has an ownership interest in the car and needs to get paid back for the money it lent.
Because payday loans are personal, unsecured loans, there is no valuable item or specific asset that a lender can take ownership of if the loan isn’t paid back. This inherently makes the loan riskier for the lended because they are relying solely on the borrower’s income stream–his or her job–in order to get the money back.
If a payday loan borrower takes out a loan and then stops paying, the lender has no recourse other than to try and get the borrower to pay them back, or file something in the borrower’s credit report showing that payments weren’t made.
Payday loans do not have traditional collateral and therefore are much riskier from a lender’s perspective. Because of this, the interest rates are usually much higher than for a home or auto loan. Lenders have to charge a higher interest rate to cover the higher amount of risk they are taking on when lending to an individual without any collateral or recourse.
If you are borrowing money through a payday loan, you will almost certainly pay a higher interest rate than you would if taking out a home or auto loan. That may not sound exciting to you, but there’s an important point to keep in mind: payday lenders can offer you same-day cash, and you do not have to put up your house, car or any other assert as collateral. Home and auto lenders will take much more time to make a lending decision. Plus, they will have to pull your credit report and do an extensive underwriting process. With a payday loan, you can get instant cash when you need it, but you do have to pay a higher interest rate to access these loans.
Quick Cash with a Payday Loan
If you’re facing financial difficulties, a payday loan is an easy way to get quick cash that just can’t be replicated by a lender that specializes in making home or auto loans. This is in large part thanks to the fact that a payday loan is an unsecured, personal loan that is not backed by any specific collateral.
Payday loans are far quicker to obtain than other types of loans. Why? The lender does not have to underwrite any asset — the car or home that you’re buying– and payday loans are almost always for much smaller amounts than would be required for a house or a car. This allows lenders to offer cash quickly and easily.
Payday loans are not intended to be used over a long time period or for large purchases, but if you just need a small amount of cash for a short amount of time, they can be the perfect solution.
If you need quick cash for back-to-school costs, car or truck repairs, or any other unexpected expenses, apply now for a payday loan.