When shopping for a personal loan, you may be able to choose between a secured loan and an unsecured loan. The main difference between secured and unsecured loans is whether or not you need collateral in order to qualify. Before you make any decisions about signing for a loan, learn what else sets these two loan types apart.
What are secured and unsecured loans?
Secured loans are loans that require you to use some type of collateral in order to qualify for funds. In the event that you default on the loan, the lender can repossess the asset used to secure the loan in order to compensate for the unpaid loan funds. However, because the lender takes on less risk with a secured loan, it’ll likely charge lower interest rates.
Unsecured loans are loans that do not require any kind of collateral in order for you to qualify for funds. You’ll need a good credit score in order to qualify for an unsecured loan, and interest rates may be higher.
Here are a few examples of secured loans:
Mortgages require the house being purchased 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.
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.
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.
Here are a few examples of unsecured loans:
These are often called “term loans” or “installment loans,” since they have a fixed period of time for repayment with monthly payments made in equal amounts.
Loans for college are usually made out to students with few assets and little credit history, so they don’t require collateral.
What are the key differences between secured and unsecured loans?
The choice between an unsecured and secured loan impacts your approval chances, your rates and fees and the need for collateral. Here are some key differences you’ll need to know about before you apply for a personal loan.
Secured loans require collateral
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.
Interest rates tend to be lower with secured personal loans
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.
Secured loans often have higher borrowing limits
Due to the financial approval requirements, secured loans tend to have higher borrowing limits, which will give you access to more money.
There are more restrictions on secured loan uses
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. With these types of loans, your options may be more limited.
It may be easier to qualify for a secured loan
If you have bad credit, some lenders may be unwilling to lend you an unsecured loan, since they perceive bad-credit borrowers as riskier. With secured loans, on the other hand, credit requirements may be lower, since the borrower takes on additional risk.
Which is better for you?
Which loan type is better for you 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. Secured loans are also usually the best choice if you have bad credit.
With 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.
The bottom line
Both secured and unsecured personal loans can help you get the cash you need, when you need it, though there are benefits and drawbacks to both. When it comes to any type of loan, shop around with multiple lenders and compare their rates and fees to ensure that you’re getting the best rates for your financial need.
FAQ about secured and unsecured loans
What does a secured loan have that an unsecured loan does not?
A secured loan serves the same purpose as an unsecured loan, but a secured loan will often offer lower interest rates and higher borrowing limits, since you’ll have to secure the loan with collateral.
Is a 401(k) loan secured or unsecured?
A 401(k) loan allows you to borrow from your existing 401(k), meaning that it’s a secured loan. While this may seem safer than using your home or savings account as collateral, keep in mind that you’re dipping into your retirement funds, and you may face fees or loan limits.