When it comes to borrowing money, there are two main categories that most loans will fit into: secured and unsecured loans. To break them down in the simplest terms, secured loans require collateral, while unsecured loans don’t. Both types of loans have their own unique advantages and things that you’ll want to look out for, and understanding the differences between the two can help you make an informed decision when choosing the best option for your financial needs. So, with that in mind, we’re going to go over what each type of loan is in more detail, look at some common examples of each, and help you get a better understanding of the differences between secured vs unsecured loans.
What are Secured Loans?
The most important thing you need to know about secured loans is that they’re backed by collateral, which is something of value that the borrower puts up to guarantee the loan. The collateral can be a car, a house, stocks, or any other asset that the lender can seize if the borrower fails to repay the loan. What a lender accepts as collateral is going to be determined by their policies and the type of loan you’re applying for. In some cases, secured loans may come with lower interest rates than unsecured loans.
4 Common Types of Secured Loans
Because a secured personal loan is a relatively broad category, there are a number of different types of personal loans that can fall under this umbrella. Here are some of the most common types of secured loans.
Mortgages are a type of secured personal loan that are used to purchase a home and the property itself serves as collateral for the loan. Mortgages are typically offered by banks, credit unions, and mortgage companies.
2. Auto Loans
Auto loans are a type of secured car loan that are used to finance the purchase of a car. Similar to a mortgage, the item that you’re buying, the car in this case, serves as collateral for the loan. Auto loans will generally be offered by banks, credit unions, and car dealerships.
3. Home Equity Loans
If you’re a homeowner and have some amount of equity in your home, home equity loans may give you the ability to borrow against the equity in your home. The loan is secured by the value of your home, and you can use the funds for a variety of purposes, like for home improvement projects.
4. Secured Credit Cards
Secured credit cards are a type of credit card that require a security deposit. The deposit serves as collateral for the card, allowing lenders to offer credit to people with poor or limited credit histories. Typically, they can be a useful tool for people who are looking for ways to impact their credit score.
Why Would I Consider a Secured Personal Loan?
Like we’ve touched on, one reason you might consider applying for secured loans is that they may come with lower interest rates than unsecured loans. This is because the lender has the added security of the collateral that you’re providing, which reduces their risk. If you have a higher credit score and a steady income, you may qualify for a secured loan with an interest rate that may be lower than what you would typically get with an unsecured loan.
Another reason for applying for secured loans depends on the purpose of why you need the funds. If you’re looking to apply for a relatively large sum of money, then you may find yourself looking into secured loans. If you look at the examples of some of the common types of secured personal loans, you’ll see that the uses of most of them is geared towards large-scale expenses like homes, cars, and home renovations.
What to Look out for with Secured Loans
While a secured personal loan can definitely be a useful tool in some instances, they also have some things that you’re going to want to be aware of before you apply for one. The biggest disadvantage is that you run the risk of losing your collateral if you fail to repay the loan. If you default on your mortgage or car loan, the lender can seize the collateral and sell it to recoup their losses. This means you could lose your home or car if you can't make your loan payments, which would obviously be a huge blow to deal with.
Another thing to be aware of is that, in a lot of cases, you won’t have the freedom to use your funds however you choose. While specific secured loans can be good for making specific purchases, they’re not typically a flexible borrowing option, like certain unsecured loans are.
What is an Unsecured Loan?
Like we’ve mentioned, the main difference between a secured vs unsecured loan is that one does not need collateral to qualify for an unsecured loan. Instead, your application will be assessed on your general creditworthiness. This means that the lender will typically look at things like your credit score, income, and other financial factors to assess your application. Because the lender doesn’t have the added security of collateral, unsecured loans may come with higher interest rates than secured loans.
4 Types of Unsecured Loans
Just like secured loans, there are a number of different types of loans that can fall under the umbrella of unsecured loans. Here are some of the most common types of unsecured loans.
1. Unsecured Installment Loans
While there are some types of installment loans that are secured, like mortgages for example, there are also short-term unsecured installment loans that are generally meant to be used differently. For starters, they are generally offered in amounts lower than some other secured installment loans like a mortgage or a secured car loan.
Secondly, with a short-term unsecured installment loan, you won’t be tied to using them for a specific purpose. They’re generally intended to be used to help you deal with an emergency expense, which could include all sorts of different scenarios.
2. Credit Cards
Credit cards are a type of revolving credit that allow you to borrow money up to a certain limit. They’re usually unsecured, outside of the secured credit cards that we mentioned earlier, which are less common. Credit cards are generally intended for everyday use, although they often come with high interest rates so it’s important that you use them carefully and responsibly.
3. Student Loans
Student loans are a type of unsecured loan that can be used to pay for college or other education-related expenses. These loans typically have lower interest rates than other types of unsecured loans, and may offer deferment or forbearance options.
4. Lines of Credit
Like credit cards, lines of credit are a type of unsecured loan that allow you to borrow money up to a certain limit. Unlike with a credit card, you won’t have a physical card that allows you to access funds. They’re a flexible borrowing option, but an unsecured line of credit should typically be used for emergency expenses versus everyday purchases.
Why Would I Consider an Unsecured Personal Loan?
One reason you might consider unsecured loans is that you don’t run the risk of losing your collateral if you fail to repay the loan. If you default on an unsecured loan, the lender cannot seize any of your assets to recoup their losses. This means that you don’t have to worry about losing your home, car, or other valuable assets if you have trouble making your loan payments.
Another reason you might consider unsecured loans is that their use can be more flexible than secured loans. Because there is no collateral involved, you can typically use the money from an unsecured loan for whatever you need, depending on the type of loan. This can include home improvements, medical expenses, and more. Having said that, it’s important that you don’t take this as an opportunity to borrow money without a real need. Always make sure to borrow responsibly.
What to Look out for with Unsecured Loans
While you won’t need to worry about losing an asset, an important thing to be aware of is that unsecured loans generally come with higher interest rates than secured loans. This is because the lender doesn’t have the added security of collateral, so they’re taking on a higher risk.
Which Type of Loan is Right for you?
Choosing to apply between a secured vs unsecured loan ultimately depends on your financial situation and your borrowing needs. If you have valuable collateral and need to borrow a relatively large sum of money, a secured loan may be the best option for you. For example, if you're looking to buy a house or a car, a secured loan may make the most sense.
On the other hand, if you don't have any collateral, an unsecured loan may be a better choice. However, keep in mind that unsecured loans often come with higher interest rates.
When deciding between a secured vs unsecured loan, it's important to consider the repayment terms, interest rates, eligibility requirements, and the potential risks and benefits of each type of loan. You should also do your research and compare different types of loans to find a suitable loan option for your needs.
Make Informed Decisions
Overall, secured and unsecured loans are two different types of loans that have their own unique purposes. When deciding between a secured and unsecured loan, it's important to do your research, consider your financial situation, and be aware of what your borrowing needs are. By understanding the differences between these two types of loans, you can make an informed decision and choose the loan that's right for you.