Personal loans can be a handy financial tool that can give you great peace of mind when an unexpected expense arises. They can also be a major financial commitment that should not be taken lightly. When you apply for a loan and take the funds, you are agreeing to put a portion of your total income each month directly toward repaying the loan.

Not adhering to these terms can result in serious consequences such as having your loan default, ruining your credit score, and in some cases having your goods repossessed.

While the size of a personal loan and the terms can vary a great deal, there are actually only two main categories of loans: secured and unsecured.

Let’s start off by examining secured loans. A loan that is secured just means that the money is “secured” against something you possess. In other words, you must offer an asset you currently own as collateral (such as car, house, or other property) for receiving the loan. If you fail to adhere to the terms of the loan, repossession of the collateral could result. When this happens, the lender sells the asset in order to recoup their loss.

There are some key advantages to taking out a secured loan. One such advantage is that you may be able to borrow more money. It is also quite possible that you will be able to negotiate more flexible payment terms, which can be arranged to be repaid over a longer time period.

Since the lender knows the collateral is available, they are usually not as concerned about being repaid, thus they become more willing to work with you. It is because of this reason that they are also more apt to offer lower interest rates. Another advantage to this type of loan is that, even if you have poor credit, you may still be able to acquire a loan.

By offering collateral, you are making a good faith effort that you will repay your loan. That being said, if you already have a great deal of existing debt, taking on more debt (a personal loan) may add too much of a burden to your already strained financial situation.

Next, let’s examine unsecured loans. Unsecured loans do not require any form of collateral to be offered in exchange for the funds. The lender simply issues a contract that clearly spells out the terms of the loan. Since this puts the lender at much more risk than those issuing a secured loan, the amount you can borrow is usually significantly lower, and must be repaid in a short amount of time.

The lending terms for unsecured loans are also much more stringent. The interest rates are higher, you must have a good credit history, and you must be able to meet certain income requirements.

There are still a few advantages of unsecured loans. One advantage is that you do not have to risk any of your personal assets, and worry about repossession. Lenders cannot stake a claim to any of your personal property, even if you default on the loan completely.

However, lenders can pursue legal action, and turn the defaulted account over to a collection agency. Unsecured loans are typically cheaper for smaller purchases than applying for a form of retail credit. Store credit lines and cards can come with very high interest rates that are compounded monthly.

This can lead to a very large bill to repay. If you will be able to repay the amount in full in a few months, an unsecured personal loan can save you a great deal of money.