What is the difference between secured and unsecured personal loans?

It’s essential that you understand the difference if you want to manage your credit effectively.

Make no mistake, the banks are in the game of managing their lending risk - it's up to you to manage yours.

These two types of loans typically come with different terms, risks, and qualifications.

This short guide can help you understand some of the issues involved when applying for either type of loan.

You’ll learn:

• What are secured personal loans?
• What are unsecured personal loans?
• What are some examples of unsecured and secured loans?

Let’s start by looking at secured personal loans.

What is a secured personal loan?

A secured personal loan is a loan that is backed by collateral. Collateral refers to a financial asset that can be provided to a lender as a form of security.

If the borrower fails to repay the loan, the lender is allowed to take possession of the item that was provided as collateral.

Lenders may accept many different types of collateral depending on the loan that is being offered.

Common examples of collateral include:

• Homes and real estate: When you purchase property with a loan, such as a home or a vehicle, the object itself often serves as collateral. If the loan goes unpaid, the deed or title passes to the lender.
• Cash security: Banks and other financial institutions may accept your cash accounts as collateral when providing you with a loan. If you fail to repay the loan, you give them the right to seize any cash left in your accounts.
• Invoices: Lenders that provide business loans may accept outstanding invoices as a form of collateral. If the borrower defaults on the loan, the lender is allowed to collect any outstanding balances that are owed by the business’ customers.

 

 

What are the features of secured personal loans?

Secured personal loans are primarily defined by the requirement of collateral, but they share many other features that set them apart. The following features do not apply to all secured personal loans but are common because of the reduced risk to lenders:

• You may qualify for lower interest rates
• You may qualify for higher borrowing limits (depending on the value of the collateral)
• You may qualify for longer repayment terms

However, not all of the features of secured personal loans are beneficial to borrowers. You may also face all of the following risks:

• You may lose the collateral that you provided
• You may need to observe stricter limits on how funds are used

Many types of loans may require security in the form of collateral. However, you may also qualify for loans that don’t require any. These are called unsecured personal loans.

The lender is protected if you default on a secured loan, but that does not mean that there are no credit consequences. If you default on a secured loan, your credit score will take the same hit it would if you defaulted on an unsecured loan.

Unsecured personal loan?

An unsecured personal loan is a loan that is provided without a form of security for the lender. While the risk for lenders is higher, these loans are common because of the flexibility that they offer both parties.

Borrowers qualify for unsecured loans based on other factors, such as:

• Credit score: You may need an excellent credit score to qualify for unsecured loans.
• Relationship with a lender: It may be easier to qualify for these loans if you have an existing relationship with the lender. For example, you may qualify more easily if you are borrowing from a bank where you have been a long-term customer.
• Favorable terms for the lender: Unsecured loans often come with terms that help the lender get their money back faster and make more off of the interest. You may qualify for these loans as long as you are willing to accept these terms.

What are the features of unsecured personal loans?

Unsecured personal loans are primarily defined by the fact that they don’t require you to provide collateral. However, there are other features that are common to these loans:

• You may be able to spend the money more freely
• The loan is often provided in cash

Due to the risk to the lender, the terms for these loans can be stricter in some ways. You may find that these loans often:

Require stricter qualification terms

Come with lower borrowing limits

Come with significantly higher interest rates

What are some examples of unsecured and secured loans?

You can only choose between these two types of loans in some cases. Most of the time, the type of loan available will depend on the purpose of the loan.

Unsecured personal loans are most common in situations where cash is being provided for general use. They are also typical in cases where the loan is being provided for an asset that doesn’t have any cash value on its own.

Unsecured loans examples:

• Credit cards
• Student loans
• Personal loans
• Personal lines of credit

Secured personal loans are common in situations where the loan is intended for a specific piece of property, such as a car or home. The property that is purchased with the loan is most often used as collateral.

Secured loans examples:

• Vehicle loans
• Mortgage loans
• Car title loans
• Life insurance loans
• Secured credit cards

Make the right choices for YOUR financial future

Now, you understand the difference between secured and unsecured loans. You also understand the features of these loans and some of the favorable or unfavorable terms that may apply to each one.

Remember that unsecured loans will typically have higher interest rates and harsher terms of repayment. However, secured loans will require you to risk a piece of valuable collateral—in addition to other penalties that apply if you can’t meet your obligations.

Use what you’ve learned to consider the value of the loan options that are available to you.