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: 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.
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.
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: The Benefits
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 it will be harder to get approved for a loan with good terms (or approved at all) if your financial profile isn’t in good shape—particularly, your credit score. If your credit score is lacking, however, don’t stress. There are plenty of reputable lenders who will approve you, but the interest rates will be far higher. LoansUnder36 and Menovo 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.
While unsecured personal loans have long been a popular choice 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.
Bottom Line: Secured vs Unsecured Personal Loans
So which is better? The truth is, no one can tell you which type of loan to take out because the right solution depends entirely on your own 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 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, than 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.