Unsecured vs Secured Loans

When exploring your loan options, the distinction between unsecured and secured loans is important. Essentially, a secured loan requires borrowers to provide collateral assets as a guarantee. But an unsecured loan doesn’t come with such restrictions. 

Key Points:

• Secured loans require borrowers to put up an asset as collateral. If the borrower defaults on the loan, the lender can take the collateral asset to recoup their losses. 
• Common secured loans include mortgages, home equity loans, auto loans, secured credit cards, and installment loans. 
• Unsecured loans allow you to borrow funds without providing an asset for collateral. 
• Common unsecured loan options include credit cards, student loans, and personal loans. 

Unsecured vs Secured Loans: Comparison

Secured and unsecured loans have different details to be aware of. Here’s a closer look at the differences between secured and unsecured loans. 

Eligibility: It’s easier to qualify for a secured loan because the required collateral makes the loan less risky for the lender. Most unsecured loans require a relatively high credit score and income. See how to get a secured business loan for more information. 

Interest rates: Unsecured loans often come with higher interest rates than secured loans. That’s because the lack of collateral makes an unsecured loan riskier for the lender. The higher risk leads to a higher interest rate on most unsecured loans. 

Repayment terms: If you are taking out a secured loan based on a large asset, like a home equity loan, then you can expect longer repayment terms than most unsecured loans. 

Fees: The fees associated with your unsecured or secured loan are often similar. For example, secured credit cards and unsecured credit cards both come with relatively high fees. 

Personal guarantee and collateral requirements: A secured loan cannot be finalized unless you provide a personal guarantee or put up assets that can be used as collateral. Unsecured loans won’t require any assets to use as collateral. But an unsecured business loan may require a personal guarantee from the founder that promises repayment from personal funds without being tied to a particular asset. 

Down payment: Down payment requirements vary based on the loan type. Typically, secured loans are more likely to require a down payment. For example, you’d have to make a down payment when obtaining a mortgage. Most unsecured loans don’t require a traditional down payment. 

Use of the loan: Secured and unsecured loans each have different usage limitations based on the loan type. For example, a personal loan, whether secured or unsecured, can be used for almost any purpose. 

Availability: Secured and unsecured loans are made available by a wide variety of lenders. But some specialize in a particular type of loan. For example, if you were seeking a mortgage, you would work with a mortgage lender. But if you were seeking a personal loan, you would find a different type of lender. 

Unsecured vs Secured Loans: The Major Advantages

When considering secured vs unsecured debt, there are many advantages to each. 

Let’s take a closer look at the options, starting with the main advantages of an unsecured loan:

No need for collateral: If you don’t want to put up an asset for collateral, an unsecured loan avoids that option. Even if you default on the loan, the lender won’t have the right to any particular asset. 

Fast approvals: If you need quick funding, an unsecured loan is the speedier option. 

Few limitations on fund usage: When you take out an unsecured loan, the lender doesn’t usually impose restrictions on the spending. You can use the funds on anything from a major purchase to a debt consolidation plan. 

Now for the advantages of taking out a secured loan:

Higher loan amounts: Depending on your available collateral, you can often obtain a higher loan amount through secured loans or asset based lending. 

Lower interest rates: The interest rates attached to a secured loan are often lower than unsecured loans. 

Bad credit is less of an issue: If you have bad credit, it can be challenging to get an unsecured loan. But since a secured loan involves collateral, bad credit borrowers have a better chance of obtaining this kind of loan. 

Build credit: If you have bad credit, making regular payments to your secured loan can give your credit score a boost. 

Longer terms: Secured loans with large assets can help you unlock longer repayment terms. 

Unsecured vs Secured Loans: The Major Risks

Of course, every loan type comes with risks. 

Let’s take a closer look at the options, starting with the main risks of an unsecured loan:

High costs: The high interest rate and upfront costs that come with an unsecured loan can make it more financially draining. 

Early repayment penalties: Some unsecured loans come with early repayment penalties. Ask your lender about any prepayment penalties before committing to a loan. 

Debt traps: Some unsecured loans come with extremely high interest rates, which makes it difficult to escape a cycle of debt. If possible, avoid payday loans with sky-high interest rates. 

Promotional offers make for a slippery slope: We’ve all seen credit card offers that seem too good to be true. And they are! The promotional period ends with higher rates and fees to sap your budget. 

Now for the risks of taking out a secured loan:

Loss of collateral: When you put up an asset as collateral, you are taking a risk. If you are unable to repay the loan, then your lender can take the asset. So, if you aren’t sure about your repayment ability, then risking a vital asset, like your home or car, could be too big a risk. 

Appraisal fees: Secured loans often come with an appraisal requirement. And the fees can add up quickly!

Lengthy approval process: Some secured loans require a long process before approval. For example, it often takes several weeks to finalize a mortgage loan application. 

Unsecured vs Secured Loan: Which One Is Right For Me?

When considering a secured loan vs an unsecured loan, the right option will vary based on your situation. Here are some examples to consider:

If you need a loan for unexpected expenses: The right option depends on your available assets and risk tolerance. If you don’t want to risk an asset as collateral, then an unsecured loan is a viable option. But you can likely unlock lower interest rates through a secured home equity loan.

If you need a loan for your small business to make ends meet: Does your business need the funds quickly? If so, an unsecured loan is a more expedient option. 

If you need a loan to grow your business: An unsecured loan with no spending restrictions is likely the best option. You want the freedom to spend the loan funds on what your business needs. 

If you have a bad credit score: A secured loan will be easier to obtain. Plus, regular on-time payments will help you build your credit score. 

If you need money fast: An unsecured loan with speedy application times could be the right fit. 

If you want to pay off an existing debt: The right option depends on your available assets and risk tolerance. You can likely unlock lower interest rates through a secured home equity loan. But if you don’t want to risk your home as collateral, then an unsecured loan is the better option. 

If you want to purchase a vehicle: A secured auto loan is likely the best option. 

How To Prepare Before Applying For An Unsecured Loan

If you want to apply for an unsecured loan, there are a few things you can do to improve your approval chances. Consider tackling these tips before you submit your application. 

Check your credit score: Take a minute to check your credit score for free. With a clear idea of your credit score, you can choose a loan type that you can qualify for. 

Repair your credit: If you find that you have a bad credit score, take action to improve it. A few ways to do this include making on-time payments and lowering your credit utilization rate. 

Clear existing debts: It’s challenging to get an unsecured loan if you already have a high debt burden. If possible, pay off your current loans. 

Get a co-signer: A co-signer with good credit can open the door to better interest rates on unsecured loans. 

Shop around: Not all unsecured loans are created equally. Shop around for the lender offering the best rates and terms for your situation. You may also wish to look into the types of collateral for loans offered by different lenders.

Conclusion 

Secured loans and unsecured loans each offer a valuable financing opportunity to the right borrower. Take some time to assess your financial situation before deciding which loan type is the best option for your situation.