Secured vs. Unsecured Loans: Differences, Pros, and Cons
Taking out a loan can be one of the most important financial decisions you make. Depending on the purpose of the loan, your credit history, and other factors, you may have the option to take out a secured or unsecured loan. To better understand each of these loan types, we’ll break down the differences between them, share some examples of each one, and lay out some scenarios where one type may be a better fit than the other.
Secured vs. Unsecured Loans Overview
Banks and other financial institutions generally offer two distinct types of loans: secured and unsecured. The main difference between unsecured and secured loans is the collateral requirement. Beyond that key differentiator, each loan can be further broken down depending on its purpose (e.g. debt consolidation or a mortgage). Let’s explore each type of loan more in-depth.
What are secured loans?
A secured loan is a type of loan that requires collateral to act as security for repayment. The collateral can be something like a car or a house. If you fail to repay a secured loan, your lender can take your collateral. Some examples of secured loans and their collateral include:
- Mortgages (house is the collateral)
- Auto loans (car is the collateral)
- Auto title loans (car is the collateral)
- Boat loans (boat is the collateral)
Secured Loans: Pros
If you have the option to choose between a secured or an unsecured loan, understanding the advantages of each can make your decision easier. Secured loans, although they require you to put up collateral before getting the loan, have two advantages when comparing them to unsecured loans.
- Potentially lower interest rates. Typically, secured loans have lower interest rates because you’ve already pledged a possession to act as security. Thus, lenders usually charge a lower interest rate than they would for an unsecured loan.
- Higher loan amounts. Depending on the value of the collateral attached to your loan, you may be able to take out more money than you would with an unsecured loan. Banks and financial institutions typically consider secured loans to be less risky and are generally willing to lend more money to a borrower through this type of loan.
- Longer repayment period. Especially for mortgages, repayment periods for secured loans are typically longer than they are for unsecured loans.
- Lower barrier to entry. Lenders will generally take a bigger chance on borrowers with lower credit scores since you’re providing collateral.
Secured Loans: Cons
As with any type of loan, there are downsides to secured loans. The biggest risk with this type of loan is that your collateral is at stake. Fail to make your payments and you run the risk of your lender claiming your possession. If you’re not willing to lose the item you’d need to put up as collateral, then a secured loan might not be the right fit for you. Another downside is that secured loans typically take longer to receive than unsecured loans
What are unsecured loans?
An unsecured loan is a type of loan that does not require any collateral from the borrower. Instead, lenders will approve you for an unsecured loan based on your credit history and other pre-determined financial requirements. Some examples of unsecured loans include:
- Credit cards
- Personal loans
- Student loans
Unsecured Loans: Pros
Just like secured loans, unsecured loans have their advantages, as well.
- No risk of losing collateral. Since unsecured loans don’t require you to provide collateral, there’s no risk of losing collateral. However, there are still ramifications and actions your lender can take if you fail to repay the loan.
- Faster approval. Lenders typically have a faster approval process for unsecured loans, which can be great if you’re in an emergency and need money fast. Some lenders even let you see if you’re eligible through a pre-qualification process.
- Flexible use. If you need money for a use that isn’t covered by a specific loan type (like paying for a big vacation or buying an engagement ring), an unsecured loan is an option. Depending on your lender, you can use an unsecured loan in more ways than you can a secured loan.
Unsecured Loans: Cons
Unsecured loans also come with their unique disadvantages. Typically, you’ll find that unsecured loans have higher interest rates due to their risky nature. If you’re not putting up collateral as security, lenders have to mitigate the risk that you won’t repay the loan with higher interest rates. Another drawback to unsecured loans is that, because there’s no collateral securing the loan, lenders can take other actions if you fail to repay it. For example, they can send you to collections, which can severely damage your credit score and remain on your credit report for up to seven years. Future lenders see these negative events as red flags and may be more hesitant to lend to you.
Secured vs. Unsecured Loan: What’s the Difference?
The key difference between secured and unsecured loans is the collateral requirement. To get a secured loan, you must provide collateral as security. While the two loans have their pros and cons, this is the main differentiator between them.
Which loan type is right for you?
Your financial situation and needs will help determine which type of loan is the right fit for you. Here are a few examples of when a secured loan might be a better fit:
- You’re buying a piece of property, like a car, home, boat, etc.
- You have poor credit and can’t get approved for an unsecured loan
- You’re willing to risk collateral to obtain a loan
Some examples of when an unsecured loan might be the best fit:
- You need a loan for a use that isn’t covered by a specific type of loan
- You want to consolidate debt through a personal loan
- You need emergency funding and want a fast approval process
Factors Influencing Your Loan Choice
You may not have a choice as to which loan you get to decide between. Your credit score is one factor that will play a role in your loan options. If you have a poor credit score, you may be less likely to be approved for an unsecured loan, and a secured loan may be your only option.
The purpose of the loan is also a factor that will affect your choices. Your choices may be limited to one loan type or the other depending on your financial situation and needs. For example, if you’re buying a house, your only option is to take out a secured loan (mortgage).
Wrapping It All Up
Understanding the difference between secured and unsecured loans will better equip you to apply for a loan that fits your needs best. Assess your financial situation and loan usage needs before applying for either type of loan. You can also pre-qualify for personal, unsecured loans for debt consolidation, major purchases, and more through Upgrade.