What’s the Difference Between Secured and Unsecured Loans?
Loans, including personal loans, can be categorized into two types: secured and unsecured loans. Secured loans are backed by collateral and tend to have lower interest rates, higher borrowing limits and fewer restrictions than unsecured loans.
Collateral for a secured loan might be the borrower’s home or car, which the lender can claim if the borrower defaults on the loan. Collateral for secured personal loans can also include funds in a savings account or a certificate of deposit. For borrowers with faulty credit, it may be easier to get approved for a secured loan, since the collateral minimizes risk to the lender.
Unsecured loans do not require any collateral. If the borrower fails to repay the loan, the lender cannot seize collateral as compensation.
It’s important to know that defaulting on either secured or unsecured loans can have negative consequences for the borrower's credit. It may lead to lower credit scores, which can make it challenging to obtain approval for future credit applications.
Examples of unsecured and secured loans
- Car loans and mortgages are common examples of secured loans, where the valuable item becomes collateral for the lender.
- Student loans, personal loans and credit card purchases are common examples of unsecured loans.
Which loan type is right for you?
The type of loan that's better for you is determined in large part by lenders and the reason you need the loan. And that leads us to the main advantages and disadvantages of secured and unsecured loans.
A benefit of secured loans can be that if you have a weak or unproven credit history, secured loans can be easier to qualify for since they mitigate the risk for your lender. The arrangement also provides another benefit: secured loans can have lower interest rates than unsecured loans. If you can repay your loan so you don’t lose your collateral, secured loans can be a money saver.
Learn more about the potential benefits of personal loans.
Are secured loans riskier than unsecured loans?
Secured loans carry a higher level of risk to the borrower compared to unsecured loans due to the potential seizure of assets in case of non-payment. Despite offering collateral, borrowers are still responsible for paying interest on the loan based on their creditworthiness. Additionally, there may be associated fees when obtaining a secured loan.
What happens if you can't pay back the loan for unsecured and secured loans?
One of the drawbacks of a secured loan is that if you have trouble paying it back, the lender may take the collateral you put up for the loan. For example, a car may be re-possessed if the loan payments are not made on a timely basis.
When you have trouble repaying an unsecured loan, you run into higher interest rates and fees that make repayment even more difficult. Lenders typically give you warnings and time to pay or options for special plans.
It’s important to communicate with your lender about issues you are having or contact a reputable credit counseling agency for help.
How can you qualify for a personal loan?
Different lenders have different requirements for loan qualifications. Generally, those qualifications include a mix of the same factors: your credit history and credit score, income, and your ratio of debt to income. When they review this information, lenders are trying to determine whether you’ll be able to repay the money they lend you. Seeing how much you have to cover your monthly expenses helps them get a clear understanding of your financial picture.
When you’re applying for a secured loan, your lender will also want to confirm the value, condition and ownership of your collateral.
What is the difference between secured and unsecured loan interest rates?
Interest loan rates are based on a variety of factors, and one of them is risk to the lender. In a higher risk loan, the lender may charge a higher interest rate, and in lower risk loans the interest rate may be lower. For this reason, you’ll typically see that secured loans have lower interest rates than unsecured loans. Secured loans are less risky to lenders, who know that borrowers are more likely to stick to the payment agreement when there is collateral at stake.
What should I know before taking out a secured or unsecured loan?
In addition to understanding the difference between secured and unsecured loans, there are several other essential steps to consider before borrowing money:
- Evaluate affordability
Before taking out a loan, assess your financial situation. Review your budget and utilize a loan calculator to determine your monthly payments and anticipated interest charges. Ensure that you can comfortably afford the loan payments and have a solid plan for repayment. Avoid borrowing more than what you need to prevent unnecessary debt.
- Compare loan offers
Review loan offers from different lenders. By doing so, you can find loan options with the lowest overall cost of borrowing. Look for competitive interest rates, favorable terms, and any additional fees or charges associated with the loan.
- Prequalification options
Some online lenders offer a prequalification process that allows you to check your loan rates without impacting your credit score. Take advantage of this opportunity to gather multiple loan offers and compare them before deciding. Take your time and research to ensure you find the most suitable loan for your needs.
Find out more about KeyBank loans and loan rates.
