Secured loans and unsecured loans. Understanding the differences between the two is an important step in achieving financial literacy, and can have a long-term effect on your financial health.
Basically, a secured loan requires borrowers to offer collateral, while an unsecured loan does not. This difference affects your interest rate, borrowing limit, and repayment terms. Unsecured personal loans typically have higher interest rates than secured loans. That’s because lenders often view unsecured loans as riskier. Without collateral, the lender may worry you’re less likely to repay the loan as agreed.
This guide will help you to further understand the difference between the two types of loans.
- The main difference between secured and unsecured loans is that a secured loan requires you to post collateral, whereas an unsecured loan does not.
- Examples of secured loans include mortgages and title loans.
- Examples of unsecured loans include credit cards, payday loans and student loans.
- A secured loan is usually easier to get and usually comes with a more favourable contract secured loan than an unsecured loan.
What is a Secured Loan?
A secured loan is a loan backed by collateral. The most common types of secured loans are mortgages and car loans, and in the case of these loans, the collateral is your home or car. But really, collateral can be any kind of financial asset you own. And if you don’t pay back your loan, the bank can seize your collateral as payment. A repossession stays on your credit report for up to seven years.
A Secured Loan Requires…
When you take out a secured loan, the lender puts a lien on the asset you offer up as collateral. Once the loan is paid off, the lender removes the lien, and you own both assets free and clear.
Some of the possessions you might be able to use as collateral in a secured loan include:
- Bank accounts (checking accounts, savings accounts, CDs and money market accounts)
- Vehicles (cars, trucks, SUVs, motorcycles, boats, etc.)
- Stocks, mutual funds or bond investments
- Insurance policies, including life insurance
- High-end collectibles and other valuables (precious metals, antiques, etc.)
Because your assets can be seized if you don’t pay off your secured loan, they are arguably riskier than unsecured loans. You’re still paying interest on the loan based on your creditworthiness, and in some cases fees, when you take out a secured loan.
Examples of Secured Loans
Mortgage – A mortgage is a loan to pay for a home. Your monthly mortgage payments will consist of the principal and interest, plus taxes and insurance.
Home Equity Line of Credit – A home equity loan or line of credit (HELOC) allows you to borrow money using your home’s equity as collateral.
Auto Loan – An auto loan is an auto financing option you can obtain through the dealer, a bank, or credit union.
What is an Unsecured Loan?
An unsecured loan requires no collateral, though you are still charged interest and sometimes fees. Student loans, personal loans and credit cards are all example of unsecured loans.
An Unsecured Loan Requires…
Since there’s no collateral, financial institutions give out unsecured loans based in large part on your credit score and history of repaying past debts. For this reason, unsecured loans may have higher interest rates (but not always) than a secured loan.
Unsecured personal loans are growing in popularity. There are roughly 20.2 million personal loan borrowers in the U.S. which you can take out a personal loan for nearly any purpose, whether that’s to renovate your kitchen, pay for a wedding, go on a dream vacation or pay off credit card debt.
Examples of Unsecured Loans
Credit Cards – There are different types of credit cards, but general credit cards bill once a month and charge interest if you do not pay the balance in full.
Personal (payday) Loans – These loans can be used for many purposes, and can vary from a few hundred to tens of thousands of dollars.
Student Loans – Student loans are used to pay for college and are available through both the Department of Education and private lenders. Although it is an unsecured loan, tax returns can be garnished to pay unpaid student loans.
What is the Difference Between Secured and Unsecured Loans?
The most important difference between a secured and unsecured loan is the collateral required to attain the loan. A secured loan requires you to provide the lender with an asset that will be used as a collateral for the loan. Whereas and unsecured loan doesn’t require you to provide an asset as collateral in order to attain a loan.
Another key difference between a secured and unsecured loan is the rate of interest. Secured loans usually have a lower rate of interest when compared to an unsecured loan. This is because unsecured loans are considered to be risker loans by lenders than secured loans.
Secured loans are easier to obtain while unsecured loans are harder to obtain, as it is less risker for a banker to dispense a secured loan. They also usually have longer repayment periods when compared to unsecured loans. In general, secured loans offer a borrower a more desirable contract that an unsecured loan would.
Overall, secured loans are easier to obtain for the mere fact that they are less risky for a lender to give out, while unsecured loans are comparatively harder to obtain.
What’s the better option – a Secured or Unsecured Loan?
Ultimately, it depends what you’re looking for. A secured loan is not only easier to get but also the contract on a secured loan is usually more favourable for a borrower than an unsecured loan. Often, the repayment periods are a lot longer, the interest rates are lesser, and borrowing limits are higher. All these factors imply that opting for a secured loan is more beneficial for a borrower.
Lenders prefer secured loans over unsecured loans as they are less risker to dispense. Since borrowers have to provide an asset as collateral to obtain a secured loan, there is a degree of assurance in the mind of the lender. The lender is assured to get back the money loaned out, and even if he doesn’t the asset can be used to recover the loss of non-payment.