Anyone contemplating a personal loan needs to be up to speed on the difference between secured and unsecured loans. They’re very different and choosing the right one for you requires taking into account a number of variables. If you simply choose one or the other without weighing their relative pros and cons, you increase your risk for an unsatisfactory outcome. You may find your application rejected. You may wind up saddled with an interest rate that’s higher than it needs to be. Or you may lose the car or other assets that you put up as collateral. In this post, we’re going to put secured and unsecured personal loans under the microscope to help you determine which is the better choice for you.
Secured vs. Unsecured Loans: How are They Different?
- Secured Loans – A secured loan is often referred to as a ‘collateral loan’ and is called that because an asset is used as collateral to borrow against. For instance, if you own a car that has been paid for, the lender will let you borrow against the value of that car. Should you fail to repay the loan in the agreed-upon fashion, the lender repossesses the car and sells it off to recoup their money. Secured loans typically carry a more reasonable interest rate because the lender is not taking a huge risk, (since they can take the car or other assets should you default). For that reason, many people prefer a secured loan.
- Unsecured Loans – With an unsecured loan there is no asset being used to guarantee the loan. If the borrower defaults, the lending institution is out of luck. Of course, the borrower will be out of luck as well since their credit will be effectively ruined for the next 7 years, which will make every aspect of their life more difficult. Because the lender is taking a bigger risk with an unsecured loan the interest rates are typically higher, sometimes much higher, than you’ll typically see with a secured loan. That said, if the borrower has excellent credit, the interest rate does not have to be prohibitive and the unsecured loan may be the best way to go. We’ll have more about interest rates in a few moments.
Where Can You Get a Secured or Unsecured Loan?
There are 3 types of lending institutions where one can acquire a secured or unsecured loan: banks, credit unions, and online lenders.
- Banks typically prefer to lend only to those with spotless credit. They also have a habit of taking their sweet time to process loan applications.
- Credit unions, on the other hand, are usually a bit easier to work with. But if you are not a member then they will not lend to you.
- Online personal loan lenders are typically much easier to work with than banks and you do not need to be a member to get a loan. The downside is that interest rates are sometimes higher. Online lenders should not be confused with companies that issue so-called ‘payday loans’.
Interest Rates for Secured and Unsecured Loans
We mentioned interest rates briefly above. Let’s take a closer look at this important issue.
- Interest Rates for Secured Loans – These loans usually have the lowest interest rates simply because the lender is not taking much of a risk. If the borrower defaults, the lender seizes the asset used as collateral. Loans may be secured with a car, a house or even a Certificate of Deposit (CD) or a savings account. Keep in mind, however, that if you use a savings account to secure a loan, you will not have access to all the money in that account until the loan is repaid. And if you use a car or house as collateral, you cannot sell either until the loan is repaid.
- Interest Rates for Unsecured Loans – If a lending institution allows a person to borrow money without offering any collateral they are taking a significant risk. If the person defaults, the lender loses their money. For this reason, unsecured loans usually come with a higher interest rate attached. This helps ensure the lender does not lose too much should the borrower default. Be aware, however, that if you have outstanding credit it may be possible to obtain an unsecured loan at an interest rate similar to what you might get with a secured loan.
The Pros and Cons of Secured and Unsecured Loans
Each type of loan has its relative strengths and weaknesses and it’s important you take them into consideration before you decide to sign on the dotted line for either type of loan. In the most general sense, here are the pros and cons of secured and unsecured loans.
Secured Loans: Pros
- They are often easier to qualify for since there is little risk for the lender.
- The total loan amount is often higher, depending of course on the value of the asset used as collateral.
- Your credit history does not usually come into play since, again, you are securing the loan with an asset.
Secured Loans: Cons
- While qualifying may be an easy bar to clear, the approval and disbursement process can take some time. Not good if you have an immediate need.
- You run the risk of losing your car, house, savings account or other assets should you default.
Unsecured Loans: Pros
- Your assets are not at risk of being seized if you encounter difficulty meeting the repayment terms.
- You can begin the application process online, which saves you time and hassle.
- If you have excellent credit the interest rates may be similar to what you would see on a secured loan.
- Disbursement often happens just a few business days after approval. Good if you have an immediate need.
Unsecured Loans: Cons
- The lender will typically conduct a credit check, which could negatively impact your credit rating.
- You might not be able to borrow as much as you would if you were securing the loan with an asset.
- If your credit is less than perfect you can expect to pay a pretty significant interest rate.
- Unsecured personal loans cannot be used for business purposes.
For smaller amounts, a vehicle-secured loan may be the best option for some people. With this type of loan, you surrender the title of your car to the lender, who returns it once the loan is paid off. Be aware, however, that even if your car has substantial value, some states impose limits on how much can be borrowed against it. Which is another reason we say that this type of loan is typically best for small loan amounts.
Secured vs. Unsecured Loans: The Bottom Line
As we have seen, both secured and unsecured loans have their upside and downside. Secured loans are typically easier to qualify for, but it may take some time to gain access to your funds. And if you default you could lose a precious asset. Whereas unsecured loans don’t put assets at risk, but often come with higher interest rates attached. On the flip side, you can begin the application process online which helps speed things up. And you will often receive your money faster.
We urge you to consider the pros and cons of each type of loan before committing to one or the other. Doing so will help ensure you pick the loan that will turn out to be in your best long-term interests.
Disclaimer: This content does not necessarily represent the views of IWB.