Secured vs. Unsecured Loan: What’s the Difference?
When you take out a loan, you’ll apply for either a secured or unsecured loan. On the surface, these two loan types are similar — you borrow money, the lender collects interest, and you make payments until you’ve paid back the borrowed amount (plus accrued interest). But take a closer look and you’ll find some big differences.
A secured loan is backed by an asset, such as your car or home. If you stop making payments on the loan, the lender can seize the asset — known as repossession or foreclosure — and try to sell it to recoup their money.
An unsecured loan is not backed by an asset, which means there is no collateral. Lenders still have the ability to try to recoup their money if you default on your loan, but it’s not quite as simple.
Here are the key differences between the two types of loans, and examples for each:
How Do Secured & Unsecured Loans Work?
Both secured loans and unsecured loans allow you to borrow money. But they have different requirements. The type of loan that you choose can determine the amount that you can borrow and the terms and interest rates you are granted. So how does each work?
Unsecured loans
An unsecured loan is not backed by an asset, which means there is no collateral. When you take out an unsecured loan, the lender is trusting you to repay the loan without holding something “against” you. The lender will set repayment terms and an interest rate that will determine your payment amounts.
Of course, if you don’t repay the loan, you will face repercussions as far as your credit report goes, but your assets will be safe. If you stop making payments on an unsecured loan, the lender can still try to recoup their money — but it won’t be as simple as seizing and selling the collateral.
Examples:
- Unsecured personal loans: Sometimes known as unsecured signature loans, borrowers typically receive their loan in one lump payment and can use the funds for nearly anything including home repairs, covering medical costs and paying for unexpected expenses.
- Debt consolidation loans: With a debt consolidation loan, the lender pays your creditors, essentially consolidating your debt under one loan. You, in turn, make payments on the loan.
- Student loans: Federal and private student loans are both unsecured, although they do differ from consumer debt in other ways.
- Payday loans: Payday loans are small loans designed to be repaid within one to two paycheck cycles. Interest rates can be as high as 400% for these loans, according to the Consumer Financial Protection Bureau.
- Most credit cards: In most cases, credit cards are unsecured. Approval for an unsecured credit card usually involves the in-person or online lender looking at your creditworthiness to determine whether you are eligible for a credit card that doesn’t require collateral.
Secured loans
Secured loans require you to put up one of your assets as collateral. You may be able to use the deed of your home, the title of your car or other assets to back your loan.
With secured borrowing, the value of your collateral plays a primary role in determining the amount of your loan. Typically, lenders use an equation known as “loan to value ratio” (or LTV) to determine your maximum borrowing limit. For example, if you’re buying a car worth $10,000, the auto financer might be willing to lend you $8,000. In this scenario, the LTV is 80%.
But collateral is not the only thing that influences your borrowing amount or terms such as your interest rate. Lenders also assess your credit profile — which happens regardless of whether the loan is secured or unsecured. The difference is that people with bad credit or no credit history are more likely to be approved for an secured loan because lenders can use the assets to recoup the loan amount if needed.
Examples:
- Home loans: Due to the large lending amount, mortgages are backed by your home.
- Auto loans: With auto loans, your lender typically keeps the title until you pay off your total due.
- Savings-secured loans: Backed by your savings account, these loans are often used to help you build credit.
- Title loans: Intended to be short-term loans, a lender holds the title to your vehicle until you pay off the loan. Title loans can carry strict repayment terms with quick repayment periods, making these loans riskier than other types of secured loans.
- Some credit cards: In certain cases, a secured credit card may be the right option. Secured credit cards require an asset, much like car loans do. In the case of credit cards, you’ll need to put forward a cash asset to fund your credit card. In a way, secured credit cards are similar to debit cards from your bank. These cards can be useful if you’re looking to build (or rebuild) credit. They can also be useful if you’re teaching a teenager how to be fiscally responsible.
What are Some Uses of Secured and Unsecured Loans?
There are certain circumstances that may warrant using a secured loan, and others that may make an unsecured loan more fitting. When it comes to borrowing money, it's important to take into account the key differences and eligibility requirements of each loan type to determine which is right for you.
Secured loan uses
Secured loans can be used for almost any purpose. They can be a great option if you have bad credit or a hard time getting a loan because you pose a higher risk to a lender. Since lenders will be able to seize any collateral that you use for the loan, it’s easier for them to recoup their losses. This security makes it easier for lenders to approve loans because it’s less risky to do so. Secured loans may also come with lower interest rates for the same reason.
Unsecured loan uses
Unsecured loans may allow you to have access to higher borrowing limits if you have good credit. This is because unsecured loan amounts are largely determined by your credit history (otherwise known as your creditworthiness) as well as your income. The issuer of your loan will determine your loan amount based on what they think you can responsibly manage and pay back on time. Since unsecured loans do not require collateral, lenders must take this into consideration to lower their risk. When lending you money doesn’t pose much risk to a lender, they may also be able to offer you lower rates.
Unsecured loans often offer more flexibility than secured loans in that they can be used for several purposes. For example, personal lines of credit and home improvement loans are common cases of unsecured loans.
Which is Best For You? How to Choose Between Secured & Unsecured Lending Options
Both secured and unsecured loans have their time and place. Both can also help you achieve your financial goals by boosting your credit score, as long as you make loan payments on time. When determining which lending option is right for you, it’s important to understand the benefits of each. You’ll want to consider the rates, payments, and other factors of each loan type.
Summing it up
Secured loans often have lower loan rates because the lender faces less risk if you neglect to repay your loan. If you refuse to repay the loan, your collateral can be seized by the lender. It may also be easier to qualify for a secured loan because of the lower risk it poses. This is especially true if you have a limited credit history or bad credit history.
Unsecured loans can be beneficial to you because it does not require collateral. This doesn’t mean that you won’t be held responsible for repaying your loan, because you still will. These loans offer greater flexibility when it comes to what you can use the loan for.
Some borrowers aren’t comfortable pledging their home or car as collateral for a loan, so they opt for an unsecured loan. Other borrowers, however, might have a perfect credit history and find the terms on a secured loan to be more attractive.
Like all financial decisions, this one is personal and depends on your unique financial situation and goals. Your past credit history can make a big impact on the type of loan you choose. The purpose of your loan can also make a difference. Remember that each loan has its own repayment terms, payment amounts and interest rates, and you should review the loan terms carefully, so you know what exactly how much you’ll owe and what your responsibilities are.
Whether you choose a secured or unsecured loan, it’s important to find a loan that meets your needs. For many people without access to lower-cost credit products, RISEcredit.com is a way to borrow. RISEcredit.com wants to help you get the cash you need as soon as the next day*, and work with you as you build a better financial future. Apply now and see if a loan at RISEcredit.com could be right for you.
The content provided is for educational and informational purposes only and does not constitute financial or legal advice. RISE is not acting as a credit counseling or repair service, debt consolidation service, or credit services organization in providing this content. RISE makes no representation about the reliability or suitability of the information provided – any action you take based on this content is at your own risk.
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