Secured Loans Vs. Unsecured Personal Loans

Some people might prefer a cash-only lifestyle, but it is inevitable sometimes to rely on credit to pay for life’s big expenses. Whether you want to own a house or a car, start or grow a business, pay for college, or renovate a kitchen, you will often find two main types of loans available—secured loans and unsecured loans.

When considering acquiring a credit, it is important to understand the differences between these two because taking any of them may have a long-term impact on your financial health.

Basically, secured loans require collateral or a valuable asset that you own, which the lender may seize if you fail to pay back your loan under the agreed terms. Unsecured loans, on the other hand, do not require any form of collateral to qualify, so you can borrow the money outright.

It can be tricky to decide which is a better option for you, so the first crucial step is getting educated on the key differences between the two and their pros and cons.

What are secured loans?

Secured loans are a type of loan that is protected by a financial asset or collateral. Lenders accept collateral to back a secured loan to encourage borrowers to repay their loan on time and avoid repossession or foreclosure. Due to the collateral, lenders are taking less risk with secured loans. This means that this type of loan carries a lower interest rate and is easy to qualify. Borrowers with good credit can get as low as 3% annual percentage rate or APR.

The lender puts a lien (or a lender’s claim to the borrower’s collateral) on the collateral if the borrower is having difficulty repaying the loan. The lien is kept active until the borrower settles the loan completely. Once the lien is lifted, the ownership of the collateral reverts back to the borrower. Otherwise, the lender will seize the asset to compensate for the unpaid loan funds.

Common types of secured loans

  • Mortgage loans: These are deemed “secured” by lenders because the house is automatically put up as collateral. This means that the house goes into foreclosure if the borrower fails to settle his secured loan.
  • Vehicle loans: Just like with a mortgage, vehicles like cars, motorcycles, boats, and even private airplanes are put up as collateral. As a consequence of the inability to pay back the secured loan on time, the vehicle will be seized or repossessed.
  • Secured credit cards: This is a good option for borrowers with no or good credit history, and it is one of the most common ways to build a good credit rating. Unlike mortgage and vehicle loans, secured credit cards require an initial cash deposit which will serve as the collateral. Failure to pay the monthly bill gives the bank the right to withdraw the cash deposit from the user’s account.

Examples of collateral items for secured loans

There are many different types of assets allowed by the law to be used as collateral. However, most lenders prefer liquid collateral or items that are easy to convert to cash. The basic principle is that the collateral must have a value approximately equal to the borrowed amount.

The most common forms of collateral are:

  • Real estate, including financial equity earned since the purchase of the property
  • Bank accounts, including savings, checking, money market, and certificate of deposit
  • Vehicles like cars, SUVs, motorcycles, boats, etc. Five Tips to Help You Get an Arizona Car Title Loan
  • Stocks or bond investments
  • Insurance policies
  • High-end collectibles like designer bags, antiques, artworks, and watches

What are unsecured loans?

Since there is no collateral requirement for unsecured loans, lenders mainly use borrowers’ credit scores and history of debt repayment to determine whether a borrower qualifies for the unsecured loan or not. They also take into consideration the current debts and income of the borrower. For this reason, unsecured loans often have higher interest rates than secured loans.

Types of unsecured loans

  • Personal loans: Also called “term or installment loans”, personal loans require a fixed repayment period. Because this type of unsecured loan is easy to obtain and can be used for any purpose, it has grown its popularity in the U.S., where a 90% growth in personal loan accounts was recorded between 2013 and 2020.
  • Revolving loans: These are the loans that borrowers can use and repay repeatedly. One example of this is credit cards.
  • Student loans: These loans are intended for students with little or no assets and credit history, thus lenders do not require any collateral.

Key differences between secured and unsecured loans

Below is a quick overview of the key differences between secured and unsecured loans to guide you in choosing the best option for your next purchase.

  • Qualifying factors: Lenders normally review borrowers’ credit score, history, and debt-to-income ratio for secure and unsecured loans, but adding collateral to the application gives lenders more confidence in lending to the borrower. For unsecured loans, a 690 or higher credit score is often required.
  • Interest rates: As a general principle, secured loans have lower interest rates than unsecured loans because the collateral for the former incentivizes borrowers to pay on time. However, a good credit score allows borrowers to obtain a better option for any of the two.
  • Borrowing limits: Secured loans generally have higher borrowing limits due to the collateral.
  • Repayments: Repayment of both secured and unsecured loans often come in fixed, monthly installments. However, secured loans may have variable rates, so the amounts of monthly payments may change.
  • How you can use the money: Secured loans tend to approve secured loans for specific purposes only, while unsecured loans come with few restrictions. As long as the money is not used for illegal activities, unsecured loan borrowers may use the loan fund as they want.
  • Where to get them: Most common lenders for secured loans are banks and credit unions. However, there are other private collateral lenders like Biltmore Loan and Jewelry, which can accept loans against collectibles as collateral. Unsecured loans, on the other hand, come very accessible through different online lenders where the process is fully online, and funding is quick.

Should you get a secured or unsecured loan?

Deciding which type of loan is better depends on your need, lifestyle, financial history, and credit score.

If you’re confident about your capacity to make payments on time, secured loans could be a better option, as they come with lower interest rates and higher borrowing limits. However, you have to weigh the risk of losing your collateral asset. For example, if you are using a car as your main access to go to work, and your lender asks for a car as collateral, getting a secured loan may not be the best idea because losing your car means a possibility of losing your job.

For this reason, unsecured loans become more practical if you don’t want to put your assets at risk. Especially if you have a good credit score, lenders may make a loan offer at a low-interest rate.