There are two ways to obtain credit. When you apply for a home and are approved, the lender secures the loan with the property you have purchased. This means should you default, the lender has the right to take away property and sell it to recover as much proceeds as possible up to the amount owed on the loan. Because of this, lenders recognize that they are partially protected and lower both their qualification criteria, as well as the interest they require on the loan. It may still involve a certain amount of credit worthiness, but requires less credit worthiness than qualifying without the security.
Unsecured loans are loans that are given without anything being used as collateral. Unsecured loans are a higher risk for lenders as they realize that if the loan is not repaid, they have no recourse other than reporting a bad loan status to your credit file. Because of this, credit qualifications become harder, and interest rates are higher. For instance, going to the bank and asking for a personal loan to purchase a vehicle would typically be a higher rate than if you obtained financing at the dealership via the same bank. Overall, it is also harder to qualify for an unsecured loan versus a secured loan.
Lenders may often at times offer lower rates and lower qualification standards for one form of credit by securing it to another. A good example is using your low interest home equity line of credit to purchase a vehicle. Even though you are able to obtain low interest financing for your vehicle, attaching the home as security is a very risky proposition. In the unfortunate case that you are unable to meet financial obligations, you risk keeping your car but losing your home. In the other case where the auto loan was secured with the vehicle, if you can’t fulfill your financial obligations on the vehicle, the only thing you would lose would be the vehicle.
