Most people borrow money at some point in their lives. Whether paying for education costs, a dream vacation, or a big-ticket item like a car or home, people often decide that a loan is the most sensible option for large purchases. Whatever the reason for a loan, borrowers should understand the difference between a secured loan and an unsecured loan.
What is a Secured Loan?
Secured loans require collateral
which refers to a valuable asset that the lender can seize if you stop making your loan payments. For example, a mortgage is a secured loan because the home acts as collateral. If you fail to meet the terms of the loan, your lender can seize the property to pay off the loan. A car loan
or boat loan
works in the same way, with the vehicle serving as collateral and “securing” the loan so it’s less risky for the lender. The most common types of secured loans include:
What is an Unsecured Loan?
Unsecured loans do not require collateral. Credit cards are examples of unsecured loans. The card issuer advances you funds, assuming you will repay what you borrow. Paying off your credit card balance is, in essence, repaying the loan. Outside of credit cards, personal loans
are another example of an unsecured loan. Failure to repay
an unsecured loan does not result in property loss, however it can result in late fees, additional interest charges, and can severely damage your credit score
. It’s also possible that the lender will get a debt collector
Because unsecured loans are not backed by any collateral, they are riskier for lenders. As such, the interest rates on unsecured loans are typically higher than secured loans. In some cases, unsecured loans may also require a co-signer
as an added layer of protection for the lender.
Which is a Better Option?
Loans impact your credit report whether they are secured or unsecured. Payment history on any loan, like a credit card, is a factor in your credit score. Your credit score can impact your ability to be approved for a loan and can also influence the interest rate and term length that you’re offered. The type of loan that’s right for you will depend on what you’re purchasing, what you qualify for, and what you’re most comfortable with. At the very least though, it’s important to understand the advantages and disadvantages of each type of loan:
Because secured loans require collateral, their interest rates are typically lower, and their loan amounts are typically higher, than unsecured loans. Secured loans usually also offer longer term lengths than unsecured loans. Collateral minimizes the lender’s risk of not receiving compensation if the loan is defaulted on, but it puts the risk on the borrower. If the borrower does not repay the loan, they could lose the property - home, car, boat, etc.
Secured loans may be a good choice when you need large amounts of money with long repayment terms and low interest rates. Depending on your credit history, a secured loan may also be easier to qualify for than an unsecured loan.
Unsecured loans pose a higher risk to lenders. No collateral is required, so lenders do not have an immediate way to recover the funds they’ve lent out if the loan is defaulted upon. As a result, interest rates are often higher with unsecured loans, and term lengths are usually shorter, compared to secured loans. The average loan amount of an unsecured loan is also typically lower than that of a secured loan.
Unsecured loans can be a good option when borrowing small amounts of money. Since they don't require collateral evaluations, the approval process is often faster than it is with a secured loan. And if the loan term is relatively short, the borrower might not mind the higher interest rate.
Ultimately, the type of loan you need will depend on your unique financial situation. If you are considering different loan options, we can help you determine which loan is the right fit. Contact us today to schedule an appointment with a lending expert.