Choosing the perfect loan for your financial situation can be difficult. There are a plethora of debt options out there, each with different terms, conditions, and costs. And knowing the differences between them could help you save money in the long run.
No matter what kind of financial product you choose, it will fall into one of two categories. It will either be secured debt or unsecured debt. Each of these forms of debt has its pros and cons. But it’s important to recognize the differences between secured debts and unsecured debts so you know what to expect when shopping for your loan.
Learn more about unsecured vs. secured debt right here!
The Difference Between Secured and Unsecured Debts
The main difference between secured and unsecured debt is that a secured loan requires collateral, and an unsecured loan doesn’t. Having a debt secured by collateral means offering up a valuable asset to the lender. A debt unsecured simply means that you can get a loan without collateral. Unsecured loans are the more common of the two types of personal loans.1
Either of these can be a big risk, depending on the lender and the conditions. When debt is secured, it’s a way for the lender to ensure that they will be repaid. If a borrower offers up a valuable item, then they’re more likely to repay, so they can get it back. Secured debts carry collateral because this collateral acts as “security” for the lender. A home is one of the most common types of collateral.2
On the other hand, unsecured loans are based almost entirely on the borrower’s promise to repay. These are often reserved for borrowers with decent credit scores and less debt since they’re more likely to be financially trustworthy.
Collateral can come in many forms. The type of collateral you need to offer will largely depend on the type of loan, the specific lender, and their terms. If you’re able to get a loan without providing collateral, that is usually preferred. This way, you won’t be risking the loss of a valuable item.
While you might not be super familiar with the terms “secured” and “unsecured,” you’re most likely quite familiar with some of the financial products that fall into these two categories of debt.
Common Types of Secured Debt
Many secured loans are designed for borrowers with less-than-perfect borrowing histories who need financial help. However, several secured loans require good scores to be considered. Secured debts are a regular part of everyday life for many. The main thing to remember is that if you can’t make your payments, the lender can seize the asset you offered up as collateral. So it can be a large risk. Here’s a list of some of the most common examples of secured debt:
Auto loans, or car loans, are ones that a borrower gets to purchase a vehicle. You can find these at the dealership, banks, or other financial institutions. These are secured debts because the vehicle acts as the collateral asset. This means that if you default on the payment, the lender can take the vehicle back since it’s technically still their property. Although you may need to have good credit for these secured loans, getting a car loan with no credit or bad credit may be possible with the right lender.
A mortgage is a debt for buying a home or property. Because homes are some of the largest purchases borrowers will make, most people can’t buy one outright. And oftentimes, you’ll need good credit to get a good mortgage, this will also help lower interest rates. This is another good example of a secured loan. Just like with an auto loan, the house or property will act as collateral. If you make your monthly payments, you keep the home. But if you default, over time, you could lose your home.
This is a product where the borrower uses their car as collateral to get quick cash. This is a common example of secured debt. To get one, you offer your car title to the lender as collateral. They then give you money based on a fraction of the vehicle’s value, and you pay it off over time. But if you can’t, the vehicle becomes the lender’s property through a process called “repossession.” Interest rates for title loans can be high.
Secured Credit Cards
Secured credit cards are similar to regular ones, with one main difference. Instead of having a certain amount of available credit from the creditor, you provide money upfront as a deposit. You then use the card and spend up to the amount that you gave them. If you default on your payments, the creditor can just take your deposit to cover the charges.
A secured credit card might not provide you with quick cash in an emergency, but it can help you build your credit score. If you’re consistently using and paying off your secured credit card, your credit score may improve. This can lead to more borrowing options like other credit cards or personal loans.
Advantages and Disadvantages of Secured Debt
There are definitely disadvantages and advantages that come with secured loans, such as secured personal loans and home equity loans:
|Advantages of Secured Debt
|Disadvantages of Secured Debt
|– More flexible eligibility requirements.
|– Sometimes higher interest rates, particularly with bad credit history.
|– Longer repayment terms possible.
|– Additional costs if default leads to asset sale.
|– Access to financing for individuals with poor credit history.
|– Reduced equity in assets like homes.
|– Opportunity to acquire large assets like homes and cars.
|– Limited ability to secure future borrowing against assets.
Common Types of Unsecured Debt
If you’ve ever shopped for a loan, then you’ve definitely come across a lot of information on unsecured debts. This type of debt, just like secured debt, comes in many forms. It’s important to be familiar with secured and unsecured products before deciding which one is right for you. Below are some common examples of unsecured debt, and these debts include:
This is one of the most common financial tools out there. A credit card is essentially just a card that allows you to spend up to a certain limit and then repay it later. The amount you can get will depend on your credit score, current credit card debt, and the creditor. Credit cards have high-interest rates.
Most credit cards are unsecured, so you won’t have to worry about providing an asset to the creditor. That being said, you can usually only get approved for most credit cards if you have a decent credit score.
A student loan is an example of an unsecured loan. You can get one through the government or from a private lender like a bank. These typically have low-interest rates, and they’re a form of unsecured debt.
Borrowers use these to pay for higher education, and it can take many years to pay back this debt.
A personal loan is a type of debt people use to pay for personal expenses, as opposed to business expenses. These come in many different forms, they vary in their terms and interest rates, and many of them don’t require you to give an asset to the lender.
There are so many different kinds of personal loan options out there. Some of these debts are good for borrowers with poor credit, some for borrowers with excellent credit. Common examples of these would be personal installment loans, bad credit loans, and bank loans.
Advantages and Disadvantages of Unsecured Debt
Here are some pros and cons of unsecured debts, starting with the advantages:
- Unsecured debt usually comes with lower interest rates than most secured debts.
- The funds can be used for various reasons with an unsecured debt.
- Since there’s no collateral with unsecured debt, taking out one of these loans doesn’t reduce the equity in any of your assets.
- Due to the simpler application process, unsecured loans can be approved more quickly, making them suitable for emergencies.
Here are some disadvantages of unsecured debt:
- Lenders might require a higher credit score or a stronger credit history to approve an unsecured loan, especially for larger amounts.
- With the ease of access to credit cards and personal loans, some individuals might accumulate more debt than they can handle, leading to financial strain.
- Unlike secured debts like mortgages, where you’re building equity in an asset (like a house), unsecured debts don’t contribute to asset accumulation.
Which Type of Loan Is Right for You?
When deciding between unsecured vs. secured debt, there is a lot of information to consider. Do you have a good enough credit history for a low-interest, unsecured loan? Do you have a low credit score and need a safe form of secured debt? What kind of asset should you offer? Can you afford the interest and payments? The type of debt you choose will largely depend on your specific financial situation.
Having a debt secured by collateral may be a good choice if you need quick cash, need to build your credit, or if you’re purchasing a large asset like a house or car. Just make sure that if you’re considering secured debts, you’re fully aware of the terms and conditions. Losing a valuable asset could make life more difficult. So make sure you can pay it off.
Unsecured debts, on the other hand, are great for higher education, quick money for emergencies, and getting a credit card or line of credit. Just be aware of the interest rates, and make sure you’re getting a good deal based on your credit score.
Both of these debt types, secured and unsecured debt, can be repaid in equal monthly installments; however, that can be different for revolving lines of credit.
FAQS About Secured versus Unsecured Debt
While it varies by lender and loan type, typical requirements for secured debt include:
-Ownership of a valuable asset
-Proof of income
-A credit check
-Proper identification and relevant legal documentation.
Lenders typically consider:
-Credit score and history
-Employment history and current income
-Payment history on other loans or credit lines
Defaulting on unsecured loans can have several consequences. First, your credit score will likely drop, making future borrowing more challenging and potentially more expensive. However, since there’s no collateral, the lender can’t immediately seize an asset like they can with a secured loan.
Some lenders may allow borrowers to convert unsecured loans into secured ones, especially if it looks like the borrower might default.
The tax implications vary based on the purpose of the loan and regional regulations. For instance, in some places, the interest paid on mortgage payments might be tax-deductible, whereas interest on personal unsecured debt is typically not.
Yes, many people have a mix of both loan types. For example, a secured personal loan and credit card.
How Can CreditNinja Help?
CreditNinja offers unsecured personal loan options for borrowers in need with less-than-perfect credit histories. If you need some extra cash, apply with us today! Also, check out our related articles in the CreditNinja Dojo to learn more about unsecured vs. secured debt and the risks and rewards of each.
- What Is the Difference Between Secured and Unsecured Loans? | Incharge.org
- Everything You Need to Know About Collateral Loans | Find the Best Loan for You | U.S. News
- What Is a Secured Credit Card? | NerdWallet
- Unsecured Loans: Borrowing without Collateral | Investopedia