There are pros and cons to both secured loans and unsecured loans. Learn more to determine which one is the best choice for you.
One of the main differences between a secured and unsecured loan is collateral. Secured loans require collateral from the borrower, while unsecured loans do not. Read more to help make the right decision for your finances.
What Is a Secured Loan?
A secured loan is funding you receive from a lender that is backed by collateral. Loan collateral are assets that could be collected to pay back your loan if you're unable to.
Collateral may include: your house, other real estate, vehicles, insurance policies, checking account, savings account, stocks, and expensive valuables or collectibles. Your home is usually the collateral for a mortgage, your car for a car loan, and your bank accounts for personal loans.
Examples of Secured Loans
Mortgages — a loan to pay for a home, your home is the collateral.
Home equity line of credit (HELOC) — allows you to borrow money using your home's equity as collateral.
Auto loans — a loan used to purchase a vehicle, with the vehicle being the collateral.
Boat loans — a loan used to purchase a boat, with the boat acting as collateral.
Recreational vehicle (RV) loans — a loan used to purchase an RV, with the RV being used as the collateral.
Secured Loan Benefits
Secured loans are typically easier to get than unsecured loans. They may be the best option if you have poor credit or are rebuilding your credit. Overall benefits include:
Looser credit requirements
Lower loan rates
Higher borrowing limits
Longer repayment terms
Can help build your credit
Secured Loan Drawbacks
Secured loans do have some drawbacks you should consider, including:
Risk of losing your assets
Possible restrictions on what you can use the loan for
Loss of assets is the biggest risk with a secured loan. Losing key assets could be detrimental to your lifestyle, so it's important to consider your ability to make secure loan payments.
What Is an Unsecured Loan?
An unsecured loan is funding from a lender that doesn't require collateral and instead is based on your creditworthiness. Banks, credit unions, and other financial institutions will look at your credit history and your credit score. It's a higher risk for them to lend you money without collateral, so they'll want to feel confident that you'll pay back the loan.
Just like with a secured loan, there are pros and cons to think through.
Examples of Unsecured Loans
Credit cards — a common type of revolving loan, borrowers can repeatedly borrow money up to a set limit.
Student loans — loans used to pay for college, students don't have to provide any collateral but tax returns and wages can be garnished to pay unpaid student loans.
Personal loans — a no collateral loan with a fixed period of time for repayment with monthly payments made in equal amounts.
Unsecured Loan Benefits
One of the biggest advantages of an unsecured loan is it doesn't put your assets at risk. Overall, you may benefit from:
Collateral-free lending
Faster loan approval
Debt being discharged if you file for bankruptcy
Unsecured loans are often preferable if you're looking for a small amount of money. They're often sought after by small businesses or startups.
Unsecured Loan Drawbacks
Even though you aren't risking your belongings, unsecured loans can have drawbacks, such as:
Higher interest rates
Additional fees
Stricter repayment terms
Lower borrowing limits
Unsecured personal loans can put you deeper in debt very quickly because of their high interest rates. If you miss payments, your debt can accumulate quickly and damage your credit score. This can then cause problems when you try to get funding later on.
Main Differences Between a Secured and Unsecured Loan?
The main differences between a secured and unsecured loan are collateral, amount of funds, eligibility, and repayment terms. The chart below offers a quick breakdown.
Secured loans | Unsecured loans |
|---|---|
• Ideal for larger loan amounts • Required collateral • Looser credit requirements • Less risk to the lender • Lower interest rates • Flexible repayment terms | • Ideal for smaller loan amounts • Doesn't require collateral • Relies on creditworthiness • More risk to the lender • Higher interest rates • Stricter loan terms |
There might be additional differences depending on the lender.
Which Loan Is Right For Me?
There isn't one answer for which is better, a secured loan or an unsecured loan. It ultimately depends on your financial situation and what you're looking for in a loan.
If you want to take out a large sum of money for an expensive purchase like a house or new car, a secured loan is probably best. If you need quick approval for a small amount of money, and have really great credit, an unsecured loan may be better.
Weigh the pros and cons of each and prioritize what's important to you. Be realistic about how much debt you're willing to take on and your ability to pay it back. Regardless of your choice, work on boosting your credit. Be conscious of your credit score, make timely payments, and reduce debt where you can. This will help you get access to funds when you need them most.