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When shopping for a personal loan, you may be able to choose between a secured loan and an unsecured loan. Before you choose, learn about the many differences between these loans. Here are some key examples.
Differences between secured and unsecured personal loans
- Secured loans are backed by collateral and unsecured loans are not.
- Interest rates tend to be lower on secured personal loans.
- There are more restrictions on what an unsecured loan can be used for.
- Secured loans often have higher borrowing limits.
- For borrowers with faulty credit, secured personal loans are easier to get.
Secured personal loans
Secured loans are available in various types, each with a particular use in mind. Typically, these loans are intended for specific purposes, all well-known and commonly used.
- Mortgage loans: When buying a house, these loans require the house to be used as collateral. If the borrower is unable to repay the loan, the house can go into foreclosure and the borrower can lose the house.
- Vehicle loans: These types of 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.
- Secured credit cards: For those with limited credit history, a secured credit card can offer the chance to build your credit score. The credit card requires a cash deposit to serve as collateral. If a monthly payment is not made, the money is taken from the cash being held as collateral.
Unsecured personal loans
Unsecured loans are intended for borrowers with a higher credit score and are available on the borrower’s signature. These loans take various forms.
- Personal loan: These are often called “term loans” since they have a fixed period of time for repayment with monthly payments made in equal amounts.
- Revolving loan: These are loans that the borrower can use and repay repeatedly. Credit cards and personal lines of credit are examples of this type.
- Consolidation loan: When a borrower requests this type of loan from a financial institution, it is typically granted on the borrower’s signature.
Differences between secured and unsecured personal loans
The first difference, and the most fundamental one, is what stands behind the loan. A secured loan is backed by collateral — such as your home or car — that the lender places a lien on in case you don’t make your loan payments. Unsecured loans aren’t collateralized, which means your creditworthiness is the only thing backing the loan, and your assets are not at risk if you default.
2. Interest rate
Because the lender can recover at least some of its losses if you default on a secured loan, interest rates may be lower. For example, Navy Federal Credit Union, the largest credit union in the United States, offers a secured personal loan with an annual percentage rate that is at least 6 percentage points less than its unsecured loan.
“That means a secured loan, if you can qualify for one, is usually a smarter money management decision versus an unsecured loan,” says Katie Ross, education and development manager at American Consumer Credit Counseling in Auburndale, Massachusetts.
3. What the loan is used for
Most unsecured loans come with 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.
But lenders tend to approve secured personal loans for specific purposes, like buying a boat or a recreational vehicle.
“An unsecured loan is always going to be easier for the consumer to use,” says Todd Nelson, a senior vice president at LightStream, the online lending arm of SunTrust Bank.
There are some secured loans that can be used for multiple purposes. For those loans, you may be able to use your own savings as collateral.
For instance, Navy Federal offers loans secured either by the money in your credit union savings or certificate of deposit account. You can borrow up to the amount in the account, and as you pay down the loan, the account funds become available to you again, says Joe Pendergast, vice president of consumer lending at NFCU.
“Any financial adviser you hear today says you should keep three to six months of savings in your accounts for a rainy day. Having that money there that you’re not going to touch for a rainy day could work to your benefit,” Pendergast says.
In some cases, you may be able to offer an asset you own as collateral, and then use the secured loan for other purposes. For example, you can take out a loan to consolidate debts and use your car as collateral, says David Hogan, chief risk and analytics officer at OneMain Financial, an Evansville, Indiana-based lender.
4. Loan amount and terms
Borrowers may be able to get approved for higher loan limits with a secured loan than an unsecured one. That’s because the lender takes on less risk when a loan is secured by collateral.
“Most often, we can offer a larger loan amount to the same customer on a secured basis when compared to an unsecured loan, which may better fit the customer’s needs,” says Hogan.
“A secured loan may also provide a longer loan term, which gives them lower monthly payments and more time to repay the loan.”
If you have poor or little credit, you may not be able to get an unsecured loan from most lenders, although some online marketplace lenders specialize in loans to borrowers with weak credit.
“A secured loan is normally easier to get, as there’s less risk to the lender,” Ross says. “If you have a poor credit history or you’re rebuilding credit, for example, lenders will be more likely to consider you for a secured loan versus an unsecured loan.”
TD Bank won’t issue an unsecured loan to anyone with a credit score below 660. But its loan disclosure lists no minimum credit score for a secured loan.
Choosing an unsecured loan
A secured loan may have a lower interest rate and a higher borrowing cap, but there are times when an unsecured loan makes more sense, or it may be your only option.
If a borrower has no collateral to back the loan, for example, he or she won’t be able to take out a secured loan, Ross says. And an unsecured loan may be the best choice for someone who doesn’t want to place their assets at risk in case of default.
“Although the borrower is likely to pay higher interest rates, the advantage in choosing an unsecured loan is that they do not have to worry about something valuable being taken away should they not pay off the loan,” Ross says. “More often than not, it is a good idea to avoid putting assets on the line whenever possible.”
Your credit may also play a role.
Lenders like LightStream cater to borrowers with excellent credit, which allows the lender to offer more favorable interest rates and loan terms than some other institutions.
There is no interest rate advantage for someone with superb credit to take out a secured loan with LightStream, Nelson says.
“The rates are now as competitive or oftentimes more competitive than the secured product,” Nelson says.