Secured Loans vs. Unsecured Loans: What's the Difference

29.04.2023
3297
16 min.

Secured loans and unsecured loans are two different types of borrowing options that are available to individuals for various purposes like buying a house or car or funding a personal project. Before taking out a loan, it is essential to understand the differences between secured and unsecured loans, as they can have significant impacts on your future finances.

Secured Loans vs. Unsecured Loans: What's the Difference

In this article, we will examine the key features of secured and unsecured loans, their advantages and disadvantages, and which one might be best suited for your financial needs. So, continue reading to learn more about the differences between secured loans vs. unsecured loans.

What are Secured Loans?

Secured loans are backed by collateral. Collateral can be any asset that has value and can be used to secure the loan. This could include a car, a house, or any other valuable possession. The lender of a secured loan will hold the collateral until the entire loan has been paid off. If the borrower defaults on their loan, the lender may take possession of the collateral and sell it in order to recover their money.

The loans have a lower interest rate than unsecured loans. Lenders feel more comfortable lending money with collateral because it reduces their risk. This means that borrowers can often borrow more money at a lower interest rate when they choose a secured loan.

Secured loans can be a good option for those who have less-than-perfect credit. Because the loan is secured by collateral, lenders may be more willing to overlook a borrower's credit history. This can be a good way for borrowers to access funds they might not get approval for with an unsecured loan.

The most popular types of secured loans are car loans and mortgages. With mortgages, the property itself serves as collateral. With a car loan, the car serves as collateral. Other types of assets that can be used for collateral include stocks, bonds, and jewelry.

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Types of Secured Loans

There are several types of secured loans depending on the asset being offered as collateral:

  1. Mortgage loans are one of the most common types of secured loans in the US. They are used to purchase or refinance a home, with the home serving as collateral for the loan. If the borrower cannot pay the loan back, the lender may foreclose on the property.

  2. Auto loans are another common type of secured loan in the US. They are used to purchase a new or used car, and the vehicle serves as collateral for the loan. If the borrower defaults on the loan, the auto lender may repossess the vehicle.

  3. Secured credit cards cards are a type of loan where the borrower puts down a cash deposit as collateral, which is used as security for the credit card. If the borrower cannot make payments on the credit card, the lender can use the cash deposit to pay off the balance.

  4. Home equity loans and home equity lines of credit (HELOCs) are types of loans where a borrower uses the equity in their home as collateral. The loan is based on the difference between the value of the home and the outstanding mortgage balance. Defaulting on the loan can cause a foreclosure on the home.

  5. Secured personal loans requires an asset as collateral, like a savings account, investment account, or personal property. If you cannot pay the loan back, the personal loan lender may seize the collateral.

Where to get a Secured Loan

Secured loans are generally easier to get than unsecured loans, as the lender has the added security of the pledged collateral. In the US, there are several options for obtaining a secured loan.

  1. Traditional bank or credit union. These financial institutions typically offer a range of secured loan options, including home equity loans, car loans, and secured personal loans. Applicants will need to fill out a loan application and provide information about their credit score, income, and the asset they plan to use as collateral.

  2. Peer-to-peer lending platform. Websites like LendingClub and Prosper allow individuals to obtain loans from a network of investors. These loans can be secured with collateral, and the interest rates are often lower than those offered by traditional banks.

  3. Title lenders. For those who need a smaller loan or who have poor credit, a title loan or payday loan may be an option. These loans are typically secured by the borrower's car and have very high interest rates. It's important to be cautious when considering these options, as they can lead to a cycle of debt.

  4. Online lenders specializing in secured loans. These lenders often offer a quick and easy application process and can provide funds within a few days. However, be sure to research the lender thoroughly and understand the terms of the loan, as these types of lenders may have higher interest rates and fees.

What are Unsecured Loans?

Unsecured loans are not backed by collateral such as a house or a car. This means that the lender is taking on more risk by lending to a borrower without any security against the loan. Instead, the lender will use the borrower's credit score and other factors, such as their employment history and income, to determine whether they are eligible for the loan and what interest rate they will be offered.

Unsecured loans can be used for a wide range of purposes, including debt consolidation, home improvements, purchasing a car, or even taking a holiday. They can be offered by banks, credit unions, and online lenders and can typically range from a few thousand dollars up to around $100,000, depending on the lender and the borrower's creditworthiness.

However, unsecured loans can also be more expensive than secured loans as the lender is taking on more risk. This means that the interest rates may be higher, and the borrower may be subject to additional fees and charges. Borrowers should also know if they cannot make repayments on an unsecured loan, their credit score could be negatively affected, and they may be subject to additional fees and charges.

Types of Unsecured Loans

There are several types of unsecured loans available in the US, including:

  1. Personal loans. These are the most common type of unsecured loan, and they are typically used for large expenses such as home renovations or medical bills. An unsecured personal loan can be either fixed-rate or variable-rate loans and are repaid over a set term.

  2. Credit cards. These are a type of revolving credit, which means that the borrower is given a credit limit that they can draw on as often as they wish. Credit cards come with high interest rates, and if the borrower fails to pay their balance in full each month, they can easily accrue a significant amount of debt.

  3. Payday loans. These are short-term loans that are designed to be repaid within a few weeks. They are typically used by borrowers who need access to cash quickly but who do not have good credit. However, payday loans often come with high interest rates and fees, which can make them very expensive.

  4. Student loans. These are loans that are used to pay for college or other higher education expenses. They can be either federal or private, but both types are unsecured loans. The repayment terms and interest rates for student loans vary depending on the lender and the type of loan.

Unsecured loans are a popular choice for many borrowers because they are typically easier to obtain and require less paperwork than secured loans. However, they often come with higher interest rates and fees, so borrowers should carefully consider their financial situation and budget before taking out any type of loan.

Where to get an Unsecured Loan

Here are some options for getting an unsecured loan in the US:

  1. Banks and credit unions offer personal loans with fixed interest rates, repayment terms, and monthly payments. The application process typically requires a credit check and income verification. The interest rates for unsecured loans vary depending on your credit score, income, and other factors.

  2. Online lenders such as SoFi, LendingClub, and Prosper offer unsecured personal loans with competitive rates and flexible repayment terms. The application process is typically fast and easy, and you can often get your funds within a few business days.

  3. Peer-to-peer lending platforms such as Peerform, Upstart, and Funding Circle connect borrowers with investors who fund their loans. These platforms offer competitive rates and flexible repayment terms. You will need to have a good credit score and income to qualify.

  4. Credit cards can also be used for unsecured loans. Many credit cards offer 0% introductory APR offers for new cardholders, which can be used to finance a large purchase or pay off high-interest debt. However, be sure to read the terms and conditions carefully and avoid carrying a balance on your credit card after the introductory period ends, as the interest rates can be high.

Unsecured loans can be a good option for those who need to borrow money without putting up collateral. Compare the interest rates, fees, and repayment terms from different lenders to find the best loan for your needs. Be sure to also consider your ability to repay the loan before taking on debt.

Secured vs. Unsecured Loans

The main difference between the two is that secured loans require collateral, while unsecured loans do not. Collateral is an asset that a borrower pledges to a lender as security for a loan. The lender can seize the collateral if the borrower fails to repay the loan.

Secured Loans

A secured loan requires a borrower to provide collateral to secure the loan.

Examples: Mortgage loans, car loans, and home equity loans.

Features:

  • Lower interest rates. Since the loan is secured with collateral, lenders consider it less risky and, thus, offer lower interest rates.

  • Higher borrowing limits. With collateral backing the loan, lenders can approve higher loan amounts depending on the value of the collateral.

  • Longer repayment terms. Secured loans offer longer repayment terms, which make monthly payments lower and more manageable.

  • Risk of collateral seizure. If you cannot repay the loan, your lender can seize the collateral to recover its money.

Unsecured Loans

An unsecured loan is a loan where the borrower isn't required to provide collateral to secure the loan.

Examples: Personal loans, credit cards, and student loans.

Features:

  • Higher interest rates. Since no collateral is securing the loan, lenders charge higher interest rates to cover their risks.

  • Smaller borrowing limits. Without collateral, lenders may offer a smaller loan amount to avoid risking their money.

  • Shorter repayment terms. Unsecured loans come with short repayment terms that will have you paying higher monthly payments.

  • No collateral seizure risk. Since there's no collateral, you don't risk losing an asset.

Overall, secured loans offer lower interest rates and longer repayment terms, but they require collateral and may be more paperwork-intensive. Unsecured loans don't require collateral, and the application process is easier, but they generally come with higher interest rates, stricter credit requirements, and shorter repayment terms.

FAQ

What is the difference between unsecured and secured lending?

The main difference between secured and unsecured lending is the presence or absence of collateral that the borrower must offer to the lender. A secured loan is supported by collateral, which is generally an asset such as a house, car, or property. In a secured loan, the borrower puts up an asset as security, which can be seized by the lender if the borrower defaults on the loan. On the other hand, an unsecured loan does not require any collateral and is based solely on the borrower's creditworthiness and ability to repay the loan.

What is a secured loan example?

A mortgage is a common example of a secured loan. In this case, the home being purchased serves as collateral. If the borrower fails to make the mortgage payments, the lender may foreclose on the property to recoup their money. Another example of a secured loan is an auto loan. The car being financed serves as the collateral, which can be repossessed by the lender if the borrower cannot pay back the loan.

Is an unsecured loan safe?

Whether or not an unsecured loan is safe depends on the individual borrower's ability to repay the loan. With an unsecured loan, there is no collateral to fall back on if the borrower defaults on the loan. As a result, these loans come with higher interest rates to compensate for the increased risk to the lender. However, if the borrower has a good credit score and a history of repaying debts on time, an unsecured loan can be a safer option compared to a secured loan.

Why are secured loans good?

Secured loans can offer several advantages over unsecured loans. Firstly, they tend to have lower interest rates since the presence of collateral reduces the risk to the lender. This can also make secured loans more accessible to borrowers who may not have the strongest credit scores. Additionally, secured loans often allow borrowers to take out larger loan amounts over longer repayment terms, making them a good option for larger purchases such as a home or car. Finally, secured loans can help borrowers build credit as long as they make timely payments, which can ultimately lead to more favorable loan terms down the line.
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