The difference between a secured vs unsecured loan is the use of collateral; unsecured loans do not require collateral, while secured loans do.
Here, you’ll learn all about the difference between secured and unsecured debt and which option may be the right financial solution for you!
What Are Secured Loans?
A secured personal loan, or secured debt, is a type of funding that requires the borrower to offer collateral. Instead of thoroughly reviewing the borrower’s financial history and creditworthiness, the lender is typically more concerned with the value of the collateral when it comes to approval for secured loans.
During the terms of a secured loan, the lender will maintain partial ownership over the collateral. However, borrowers can usually maintain possession and use of their collateral as long as they keep up with their loan payments.
What Is Collateral?
Collateral is a valuable asset, such as a home or vehicle, that borrowers use to secure a loan agreement. The value of the collateral acts as security for the loan because lenders can repossess the collateral and utilize its equity if the borrower defaults on their loan agreement. Since lenders have the security of the collateral, they can often approve a wider variety of consumers, such as bad credit borrowers, for secured personal loans.
Types of Secured Loans
Below are a few examples of some commonly sought-after secured personal loans.
Auto Loans
An auto loan is funding for financing a new or used vehicle. With auto loans, the car itself is used as collateral. More than 40% of Americans have an auto loan.1 Once the borrower fully repays their auto loan, they will own their vehicle outright.
Car Title Loans
A car title loan is a type of funding available for vehicle owners. With title loans, the vehicle title is used as collateral. Lenders will sign onto the borrower’s vehicle title as a lienholder, giving the lender partial ownership over the vehicle.
Mortgages
A mortgage is a loan used for financing a home. Mortgages are perhaps some of the most complicated loan types available and can take weeks or even months to initiate.
Home Equity Lines of Credit (HELOC)
A home equity line of credit is a loan that also uses the borrower’s home as collateral. Sometimes, home equity lines of credit are referred to as a second mortgage because borrowers can have a mortgage and a HELOC open at the same time.
Secured Credit Cards
A secured credit card is a kind of credit where the borrower puts down a cash deposit or security deposit when opening an account. The amount of the security deposit will also equal the amount of the borrower’s credit limit. This security deposit acts as collateral, so if the borrower fails to repay their balance, the lender has the security deposit to make good on their loan.
What Are Unsecured Loans?
An unsecured personal loan is a type of loan that does not require collateral. Instead, lenders will use the applicant’s credit report and credit scores to decide how much of a lending risk they pose. Borrowers can access unsecured personal loans via a financial institution like a bank, credit union, or another direct lender.
Types of Unsecured Loans
Check out some info on some of the most popular types of unsecured personal loans.
Personal Loans
Personal loans, sometimes called personal installment loans, are a versatile type of loan that borrowers can use for virtually any expense. According to Market Watch, over 22 million Americans have a personal loan.2 Many consumers often turn to personal loans when they need funding because they can come in so many forms, with options available for both good and bad credit borrowers.
However, since personal installment loans are unsecured, the lender will look at the applicant’s credit score and financial history when determining loan approval, interest rates, loan terms, loan amounts, etc.
Cash Advances
Cash advance loans, like payday loans, are a type of loan designed to get consumers some extra cash while they are waiting for their next paycheck. Since these loans are only meant to supplement income until borrowers get paid by their employers, loan terms are usually about two weeks. Furthermore, these kinds of quick cash loans also usually come with extremely high-interest rates. So, while these loans may be easy to get no matter what type of credit you have, they may come with some serious consequences that can end up making your financial situation even worse.
Unsecured Credit Cards
An unsecured credit card is a revolving line of credit that borrowers have renewed access to each month. Similar to unsecured loans, credit card issuers will also look at the borrower’s credit history and credit score when determining financing details like interest rates and credit limits.
Secured and Unsecured Loans: Which Is Better?
So which option is better, a secured or unsecured loan? Well, that’s going to depend on a few circumstances. Factors like what you’re looking to pay for, your income, and your current financial situation are going to determine if secured or unsecured personal loans will be the best option for you.
Below are some of the benefits consumers may enjoy with secured and unsecured debts.
Advantages of Secured Loans
Lower Lending Risk
Since lenders have collateral as backup to secure their loan, they are almost guaranteed repayment; either the borrower will repay, or the lender can claim ownership over the collateral and its equity. Due to this reduced lending risk, lenders are often able to approve a wider variety of borrowers and offer higher loan amounts.
Bad Credit Is OK
Because of the lower lending risk of secured loans, lenders can approve just about anybody who has collateral with enough equity. This means bad credit consumers are often able to access funding via a secured loan when they may not have been able to get a loan anywhere else.
Sometimes, Longer Repayment Terms
Some secured loans, like mortgages, have longer repayment terms than other types of loans. Usually, mortgage borrowers will have the option to repay their loan over the course of 15, 20, or 30 years. Other types of loans, like personal installment loans, typically give the borrower a few months to a few years to repay.
Advantages of Unsecured Loans
No Risk of Losing Collateral
Since there is no collateral required, borrowers of unsecured loans don’t have to worry about potentially losing any of their property. However, just because borrowers don’t lose any physical property doesn’t mean there are no negative consequences for not repaying an unsecured loan. Credit score damage due to missed payments or default can pose just as much of an inconvenience as a lost car or other asset.
Can Cover a Wide Variety of Expenses
Some secured loans, like mortgages or auto loans, dictate what the borrower can spend the loan money on. Mortgages are for purchasing homes, and auto loans are for purchasing vehicles. With an unsecured loan, borrowers can pay for just about any expense, from debt consolidation to extensive home repairs!
Good Credit Borrowers May Get Faster Approval
If you have a positive credit history, it should be obvious to lenders that you pose a low lending risk as a borrower. Therefore, consumers with excellent credit are often able to get pre-approval offers or a speedier application process, allowing them to access their approved funds ASAP.
What Happens if I Don’t Repay my Secured Loan?
If a borrower defaults on their secured personal loans, they risk losing whatever asset they offered as collateral. For example, borrowers who default on their mortgage may have their home foreclosed on, and borrowers who default on car title loans risk having their vehicle repossessed by the lender.
Not only may the borrower lose their collateral if they default on a secured personal loan, but their credit score may also take quite a hit. In fact, borrowers who miss just one payment on a loan or bill can have a delinquency on their credit report that brings down their score for up to seven years!
What Happens if I Default on Unsecured Loans?
While borrowers of unsecured personal loans don’t have to worry about losing any collateral if they default, they will have to worry about substantial damage to their credit history and credit score. Furthermore, if borrowers of unsecured loans default and fail to make an effort to repay their loan, they risk having their debt sent to a collection agency. At that point, the borrower will have to deal with a debt collector, which can mean inconvenient and annoying phone calls from the agent trying to collect the debt.
How To Avoid Default on a Secured and Unsecured Personal Loan
| Strategy | Secured Loan | Unsecured Loan |
| Budgeting | Create a detailed budget to ensure you can meet your loan payments along with your other financial obligations. | Essential for managing payments without collateral. Prioritize loan payments in your budget planning. |
| Communication | Contact your lender as soon as you anticipate difficulty in making payments. They may offer loan modifications, forbearance, or other options to help. | Early communication is key. Lenders may offer payment plans, interest rate reductions, or temporary forbearance. |
| Emergency Fund | Build an emergency fund to cover monthly payments in case of financial hardship, such as job loss or unexpected expenses. | An emergency fund is crucial for maintaining payments during tough times, reducing the risk of default. |
| Extra Payments | Whenever possible, make extra payments to reduce the principal faster, which can lower the overall interest paid and shorten the loan term. | Additional payments can help reduce the debt faster and save on interest, providing more flexibility in financial crises. |
| Refinancing | Consider refinancing to secure a lower interest rate or more favorable terms if your credit situation has improved since the original loan. | Refinancing or consolidating unsecured loans can lower payments and interest rates, making it easier to manage debt. |
| Debt Counseling | Seek advice from a reputable credit counseling agency for strategies to manage your loan and other debts effectively. | Credit counseling can provide valuable insights into managing unsecured debt and potentially negotiating better terms with creditors. |
| Prioritization | Prioritize payments on secured loans to protect essential assets, like your home or car, from repossession or foreclosure. | Prioritize according to interest rates, typically paying off higher-rate loans first (avalanche method) or focusing on smaller debts for quicker wins (snowball method). |
| Financial Planning | Regularly review and adjust your financial plan to accommodate changes in your income or expenses, ensuring you can continue to meet your loan obligations. | Continuous financial planning is vital to adapt to changes in financial circumstances, keeping unsecured loan payments manageable. |
FAQ: Secured and Unsecured Debt
Switching directly between secured and unsecured loans is uncommon due to their differing structures. However, refinancing options may allow you to transition between the two based on improved creditworthiness or the desire for better loan terms.
Both types of loans affect future credit opportunities; timely payments can improve your credit score. Secured loans offer a longer credit history, while unsecured loans can influence your credit utilization ratio, affecting your score.
Yes, the choice depends on your financial needs and risk tolerance. Secured loans are typically for larger purchases with collateral, while unsecured loans are better for smaller, personal expenses without risking assets.
Bottom Line: Secured and Unsecured Loans
Whether you’re getting a secured or unsecured loan, it’s important to research lenders and compare your options before submitting an application. You may even want to consider other options that don’t require you to take out a loan at all. That way, you can save money on interest rate charges and protect your credit score and finances from acquiring more debt! Some non-loan alternatives that may be able to help you cover your expenses are:
- Using funds from savings accounts or an emergency fund
- Having a garage sale or selling some of your gently used items online
- Asking a close friend or family member for a small loan
- Getting a temporary part-time job to earn some extra cash
Want to learn more about different types of loans, handling your finances, and more? Check out the CreditNinja dojo for tons of free resources!
References:
