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If you’ve ever taken out a loan before, or even if you’re new to the process, than it’s likely you’ve heard your fair share of financial jargon, such as secured and unsecured personal loans. These are two types of personal loans, and the more you know about the varying loan options out there, the better.
Along with secured and unsecured loans, you also have student loans, auto loans, fixed-rate loans, variable loans, and so on. We’ll be focusing on secured and unsecured personal loans in this article, but remember that the variety of loan products out there exist to meet the needs of the variety of borrowers and their complex financial situations.
In other words, depending on your creditworthiness and overall financial goals, there’s a loan for you!
So if you’re in the market for a personal loan, how do you choose between secured vs. unsecured personal loans? Let’s break these terms down into digestible pieces so you can make the smartest choice.
Secured Personal Loan
A secured personal loan is just that: it’s secured, meaning it’s backed by collateral—be it your home or some other valuable asset. Securing your loan with collateral makes you a far less riskier borrower in the eyes of a lender because if you happen to default on your loan and can no longer make payments, the lender at least has the collateral, which they can seize to help pay for the loan.
However, if this collateral isn’t enough to pay off what you owe you’re still responsible for paying the remaining amount back to the lender.
Secured Personal Loan Pros and Cons:
Secured personal loans are those which require you to provide some form of collateral, such as a car or a house, to back the loan. This security measure reduces the risk for the lender and can, therefore, offer benefits like lower interest rates, higher borrowing limits, and easier approval.
Secured Personal Loan: The Benefits
So why would someone willingly put up something as important as their home to back up a loan when it’s not even mandatory? Interest rates!
If you’ve ever shopped around for a loan, then you know how trying it can be to find a lender offering low interest rates, especially if your credit score and financial profile are lacking. The best interest rates are typically reserved for those with good to excellent credit, steady income, and an overall healthy credit report.
So what are the rest of us to do, pay high interest rates and call it a day? Well, that’s one option, but another popular solution is to secure your loan with collateral. Loan providers will offer lower interest rates for loans that are secured than those that aren’t, which can be an enticing prospect to some borrowers.
Another perk to taking out a secured loan is that you can likely acquire a larger loan amount since lenders feel confident that they’ll get their money back—either from your monthly payments or from your valuable collateral.
Secured Personal Loan: The Downside
Secured loans may offer lower interest rates than unsecured personal loans, but as you can guess, they’re far riskier. If you’re suddenly unable to make your monthly loan payments, the last thing you want is to have your property or other collateral seized.
Life isn’t always predictable and if you happen to encounter financial difficulties, you could lose your valuable asset. Additionally, if the asset doesn’t cover the entirety of the loan, the loan provider can still come after you until you pay the remaining amount.
Best For:
Secured personal loans aren’t as popular an option with borrowers simply because there’s always the risk of losing the asset, but it can be a good option for those with poor credit who are having difficulty getting approved for an unsecured personal loan.
Examples of Secured Loans:
- Auto loan: The car you purchase is used as collateral for the loan, meaning the lender can take the car if you default on your payments.
- Home equity loan: A home equity loan is a secured personal loan that is used to borrow money against the equity in your home.
- Personal loan with collateral: A personal loan with collateral is a secured personal loan that uses a different asset as collateral; the lender can take the collateral to recover their loss.
Unsecured Personal Loans
The only difference between a secured loan and an unsecured loan is that an unsecured loan is not using any collateral to back it up. This is generally the more popular of the two personal loan types.
Since there’s more risk for lenders, they will look at a variety of factors to determine a borrower’s creditworthiness and financial health, such as credit score, payment history, employment history, income, and more.
If a borrower defaults on their loan, while they don’t run the risk of losing their valuable property, as is the case with a secured personal loan, they still face serious consequences, such as a hit to their credit score and possibly collections. This goes for pretty much any form of unsecured loan, including credit cards, student loans, and personal lines of credit—not just personal loans.
Unsecured Personal Loan Pros and Cons:
Unsecured personal loans do not require collateral. This means there is no direct risk to your personal assets if you are unable to repay the loan. This type of loan often comes with a faster approval process and offers flexibility in its use.
The biggest upside to taking out an unsecured personal loan is that it doesn’t require any collateral to back it up—so overall, it’s far less risky than a secured personal loan.
Another benefit is that the application process is much quicker and easier since you aren’t dealing with securing the loan with an asset, which involves a few more steps.
Unsecured Personal Loan: The Downside
The downside to taking out an unsecured personal loan is that interest rates will be higher since the loan provider is taking on more risk by lending you a loan that isn’t secured by collateral.
This means getting approved for a loan with good terms (or approved at all) will be harder if your financial profile isn’t in good shape—particularly your credit score. If your credit score is lacking, however, don’t stress. Plenty of reputable lenders will approve you, but the interest rates will be far higher. LoansUnder36 and 5kfund are two examples of companies whose applications do not require a minimum credit score.
If you’re having trouble getting approved for a personal loan or getting decent rates, adding a co-signer with a better credit score can help.
Best For:
While unsecured personal loans have long been popular for people of all financial backgrounds, they generally work best for those with good to excellent credit scores who don’t want to back up the loan with collateral. These borrowers are going to get the best interest rates and loan terms.
Both secured and unsecured personal loans can be used for a variety of purposes, such as financing a large purchase, consolidating debt, refinancing, funding home improvement projects, and so much more.
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What is the Difference Between Secured and Unsecured Loans?
When deciding which type of loan best fits your needs, it's important to understand the key differences between secured and unsecured loans. These differences primarily revolve around four main aspects: collateral, interest rates, borrowing limits, and requirements to qualify.
Collateral
The most defining difference between secured and unsecured loans is the collateral requirement. Secured loans require collateral, which can be any valuable asset like your house, car, or savings account. This collateral is essentially a form of security for the lender. If you default on the loan, the lender can seize the asset to recover their loss. On the contrary, unsecured loans do not require collateral. Your personal assets are not safe even if you default on the loan.
Interest Rates
Interest rates also significantly differ between these two types of loans due to the risk factor. Generally, secured loans offer lower interest rates since the lender's risk is minimized by the collateral. Conversely, unsecured loans present more risk to the lender as there's no collateral involved, leading to higher interest rates.
Borrowing Limits
Secured loans typically offer higher borrowing limits, largely determined by the value of the collateral. So, a secured loan may be more suitable if you need to borrow a large amount of money. Unsecured loans, however, usually have lower borrowing limits because they are not backed by collateral and thus carry a higher risk for the lender.
Requirements to Qualify
The requirements to qualify for a loan also vary. For secured loans, even with a poor credit score, you might still qualify because the loan is backed by collateral, providing a safety net for the lender. However, for unsecured loans, lenders usually require a good to excellent credit score, a stable income, and a strong repayment history, given there's no collateral to fall back on in case of default.
Bottom Line: Secured vs. Unsecured Personal Loans
So which is better? No one can tell you which type of loan to take out because the right solution depends entirely on your financial situation. If you’re having trouble getting approved for an unsecured personal loan due to a low credit score and are unable to get a co-signer to help with your application, then a secured personal loan may be the way to go as long as you’re aware of the risks.
If you don’t like the idea of putting up a valuable asset to back up your personal loan for the sake of lower interest rates, or if you have good to excellent credit, then an unsecured personal loan is a great option.
Overall, it’s important to carefully evaluate what your options are along with the pros and cons of each before making a choice, but hopefully, you’re now better equipped to move forward and find the best loan provider for you.
FAQ:
Q: What are the disadvantages of unsecured personal loans?
A: Unsecured loans typically have higher interest rates than secured loans, may be more difficult to qualify for, and could result in the loss of personal assets if defaulted on.
Q: Do secured personal loans affect your credit score?
A: Secured loans do not hurt your credit and can actually help build credit by showing timely repayment. However, if defaulted on, the lender may repossess the collateral, which could damage your credit score.
Q: Which type of personal loan builds credit faster: secured or unsecured?
A: Secured loans typically build credit faster than unsecured loans because they are backed by collateral, which makes them less risky for lenders.
Q: Why do people get unsecured personal loans?
A: People get unsecured loans for a variety of reasons, such as consolidating debt, paying for unexpected expenses, or making a large purchase. They can also be used to improve credit score.
Q: When is it best to use an unsecured personal loan?
A: You should consider using an unsecured loan when you need to borrow money and don't have any collateral to offer. It may also be a good option if you have good credit and need to borrow a small amount of money.
Q: How much can you borrow with an unsecured personal loan?
A: The amount of money you can borrow with an unsecured personal loan will vary depending on your credit score, income, and other factors. However, most unsecured personal loans range from $2,000 to $50,000.
FAQ
What are the disadvantages of unsecured personal loans?
Unsecured loans typically have higher interest rates than secured loans, may be more difficult to qualify for, and could result in the loss of personal assets if defaulted on.
Do secured personal loans affect your credit score?
Secured loans do not hurt your credit and can actually help build credit by showing timely repayment. However, if defaulted on, the lender may repossess the collateral, which could damage your credit score.
Which type of personal loan builds credit faster: secured or unsecured?
Secured loans typically build credit faster than unsecured loans because they are backed by collateral, which makes them less risky for lenders.
Why do people get unsecured personal loans?
People get unsecured loans for a variety of reasons, such as consolidating debt, paying for unexpected expenses, or making a large purchase. They can also be used to improve credit score.
When is it best to use an unsecured personal loan?
You should consider using an unsecured loan when you need to borrow money and don't have any collateral to offer. It may also be a good option if you have good credit and need to borrow a small amount of money.
How much can you borrow with an unsecured personal loan?
The amount of money you can borrow with an unsecured personal loan will vary depending on your credit score, income, and other factors. However, most unsecured personal loans range from $2,000 to $50,000.
Article Topics
Personal Loans
Jessica Cotzin is a writer and the Lendstart authority on small businesses and personal loans. She has been writing about personal finance and the loans industry for a number of years, and holds a bachelor’s degree in journalism from Florida Atlantic University.
