When shopping for personal loans, borrowers will find that there are two main types of loans — secured personal loans and unsecured personal loans. A secured personal loan is backed by collateral, meaning something you own can be taken by the bank if you do not pay the loan under the agreed terms. An unsecured personal loan does not require any form of collateral for you to qualify.
Both types of personal loans have their pros and cons. With the growth of Fintech companies, unsecured personal loan usage is growing because borrowers have access to more options for lending. By the end of Q1 in 2019, 19.3 million Americans had at least one unsecured personal loan.
With so many lending options available, it can be tricky to decide the best option for you. Gathering the facts about both secured and unsecured personal loans is a great first step in taking out a personal loan.
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 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 to qualify for an unsecured loan from many lenders, and interest rates may be higher.
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. With good credit, you can expect rates to start as low as three percent APR.
Here are a few examples of secured loans:
- Mortgages: 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.
- 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, typically between $200 and $500. The amount you deposit will be your credit limit. If a monthly payment is not made, the money is taken from the cash held as collateral.
Unsecured loans don’t require collateral, but failing to pay on time can result in a bad credit score. Your debt can also be sent to a collection agency if you don’t pay off your loan within the terms of the lender.
Here are a few examples of unsecured loans:
- Personal loans: These are often called “term loans” or “installment loans,” because they have a fixed period of time for repayment with monthly payments made in equal amounts.
- Revolving loans: These are loans that the borrower can use and repay repeatedly. Credit cards and personal lines of credit are examples of this type.
- Student loans: 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.
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 will get more favorable rates for either type of loan. A good credit score is typically considered anything 670 or higher.
Due to the financial approval requirements, secured loans tend to have higher borrowing limits, which will give you access to more money.
How you can use the money
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.
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.
Requirements to qualify
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.