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When shopping for personal loans, borrowers will find that there are two main categories: secured and unsecured personal loans. A secured loan is backed by collateral, meaning something you own can be seized by the bank if you default on the loan. An unsecured loan, on the other hand, does not require any form of collateral.
Both types of personal loans have their pros and cons. But with so many lending options available, deciding the best option for you can be tricky. Gathering the facts about secured and unsecured loans is a great first step in obtaining a personal loan.
Secured loans are often used for purchases that need larger loan amounts — like a home loan or an auto loan. Lenders like secured loans because they are taking less risk. Borrowers like secured loans because you can typically get lower interest rates.
Types of secured loans
Although some lenders offer secured personal loans, which can be used for almost any purpose, these are some of the most common types of secured loans you’ll find in the market.
- Mortgages: Mortgages require the house being purchased to be used as collateral. If the borrower defaults on the loan, the house can go into foreclosure and the borrower can lose the house.
- Secured credit cards: For those with limited credit history, a secured credit card can offer the chance to build their credit score. The credit card requires a cash deposit to serve as collateral and your credit limit.
- Vehicle loans: Auto loans are available for cars, trucks, motorcycles and boats. The vehicle is used as collateral. Not repaying the loan can result in the vehicle being repossessed by the lender as repayment.
Where to get a secured loan
Several financial institutions offer secured loans, such as banks, credit unions and online lenders.
Pros of secured loans
- Less stringent eligibility requirements.
- Often feature lower interest rates than unsecured loans.
- Higher borrowing limits than unsecured loans.
Cons of secured loans
- Collateral can be taken if you default on the loan.
- Failure to repay the loan as agreed can damage your credit.
- There tend to be restrictions on how you can use the funds.
Unsecured loans don’t require collateral and are issued based on credit. Because the lender is assuming a greater risk by not asking for a collateral, these loans tend to have more stringent credit and income requirements than secured loans. Failing to repay an unsecured loan can also result in dents in your credit score and — in the worst of cases — your account could be sent to a collection agency.
Types of unsecured loans
Unsecured loans tend to be more versatile when it comes to how you can use the funds.
- Personal loans: These are often called “term loans” or “installment loans,” because they have a fixed period for repayment with monthly payments made in equal amounts.
- Revolving loans: These are loans that allow borrowers to spend as they go. Credit cards and personal lines of credit are examples of this type.
- Student loans: These loans can be either federal or private, with standard repayment terms of 10 years. However, student loans can only be used to pay for college-related expenses, such as tuition and fees, course materials and room and board.
Where to get an unsecured loan
Just like secured loans,unsecured loans can be obtained from a bank, credit union or online lender.
Pros of unsecured loans
- A lender can’t take your assets if you default on the loan, at least without a court’s permission.
- No collateral required.
- Flexibility on how you can use the money.
Cons of unsecured loans
- Often have higher interest rates than secured loans.
- Some lenders may charge origination fees of up to 10 percent.
- It may be tough qualifying for them with bad credit.
- Defaulting on the loan can cause serious credit damage.
What is the difference between secured and unsecured loans?
Secured and unsecured personal loans differ in five areas: the need for collateral, interest rates, the amount you can borrow, how you can use the funds and what you need to qualify.
The primary difference between secured and unsecured loans comes down to collateral. With a secured loan, you give the lender the right to seize the asset you use as collateral should you fail to repay the loan. With an unsecured loan, no assets are required — though you’ll still face credit implications if you default on your loan payments.
Lenders take on less risk with secured loans since the borrower has more incentive to repay the loan. Because of this, interest rates are typically much lower. However, with a good credit score you can still get favorable rates for either type of loan. A good credit score is typically considered 670 or higher.
Due to the financial approval requirements, secured loans tend to have higher borrowing limits, giving you access to more money. But you may still be able to get unsecured loans of $100,000 or more.
How you can use the money
Most unsecured loans have few restrictions on how the money will be used. As long as the loan proceeds aren’t going toward gambling, buying securities, illegal activities or, in some cases, college expenses, you’re free to spend the money as you please.
Requirements to qualify
Although some lenders may be willing to issue you an unsecured loan with bad credit, most of them shy away from this, as you’re considered a riskier borrower. With secured loans, on the other hand, credit requirements may be lower since the borrower takes on additional risk by putting an asset on the line.
How to choose the best loan type
Which loan type is better depends on your need, financial history and credit score. Since secured loans will often have lower interest rates and higher borrowing limits, they may be the best option if you’re confident about being able to make timely payments.
That said, an unsecured loan may be the best choice if you don’t want to place your assets at risk. Interest rates may be slightly higher, but they could still be competitive if you have good credit.
Both secured and unsecured personal loans have distinctive benefits and drawbacks. Regardless of which type of loan you may go for, make sure to shop around with multiple lenders and compare their rates and fees to ensure that you’re getting the best rates for your financial need.