Secured vs. Unsecured Loans: What’s the Difference?

Currently, 30% of Americans have between $1,001 and $5,000 in credit card debt, and 6% have over $10,000. This is a frightening number to think about, especially since these pieces of plastic come with high interest rates.

Credit cards can be a great resource if you’re behind on bills or have an emergency. But there are better choices available: personal loans. These come in two forms (secured vs. unsecured), and both have their own strengths and weaknesses.

Keep reading to learn everything you need to know about secured and unsecured loans.

What Is a Secured Loan?

Secured loans are personal loans that are backed by collateral from the borrower. Usually, this is a car or house, although it can be other things too, like stocks or bonds.

If the borrower cna’t pay the loan, then the lender can seize the collateral. This also means that the lender is the owner of the deed or title until the borrower pays the full loan amount back.

Some examples of secured loans include mortgages, payday loans, auto loans, and home equity loans.

What Is an Unsecured Loan?

As the name suggests, an unsecured loan is the opposite of a secured loan. The borrower doesn’t need to offer collateral or security to the lender. This means that the lender has to take on more risk, as there’s nothing to fall back on if the borrower defaults.

The main way lenders make up for this is by performing credit checks and having more stringent qualifications. This helps them screen out those who are likely to make repayments late or miss them completely.

Some examples of unsecured loans include credit cards and student loans.

Secured vs. Unsecured Loan: Similarities

You can get both types of loans from online lenders, as well as banks and credit unions. But what other similarities do these loans share?

Set Repayment Periods

When you sign a personal loan, you agree to set loan terms, which include your repayment period. With both, you’d typically make monthly payments until you’re done with the balance.

If you miss any, then you’ll face penalties; miss enough payments, and you’ll default. This can have serious consequences for your credit score, as well as your financial stability.

Credit Checks

A credit check shows a person’s history of how responsible they are with money. It’ll tell a lender about your credit (both past and present), if you made payments on time, and how much total debt you have.

It makes sense then that they’d perform credit checks with both types of personal loans.

Interest

Lenders make money by charging interest on the loans they give out. Regardless of which type of loan you choose, you’ll always have to pay the amount borrowed plus interest back.

The exact interest charged will depend on which loan you apply for (more on this later), as well as your credit score, debt-to-income (DTI) ratio, current income, and employment history.

Secured vs. Unsecured Loan: Differences

While they’re both personal loans with many similarities, secured and unsecured loans have major differences that can make one more worth it than the other for you. These are the main ones you should be aware of.

Qualifications

Yes, lenders will perform credit checks regardless of which loan you apply for. However, the qualifications will be much more rigorous for unsecured loans. Not to mention, the qualifications will differ as well.

For example, lenders will want to see higher credit scores and income levels for unsecured loans. They’ll also take a look at the money you have in savings or investment accounts.

On the other hand, secure loan lenders will want to see a certain level of equity in the collateral you offer.

Approval Rates

In general, it’ll be easier to get approval for a secured loan. As long as you have worthy collateral, your chances of approval are high. This makes it a good option for those who have lower credit scores.

Those without excellent credit scores may find it difficult to find a lender for unsecured loans. So they may have no choice but to opt for the secured route.

Repayment Terms

Both loans have set repayment periods. However, you’ll generally see longer ones with secured loans.

This is because lenders have collateral, which creates security. They don’t feel as much urgency in getting their money back, as they can take and sell the collateral if needed.

Whereas with unsecured loans, the repayment terms are typically shorter. In addition, the monthly payments are larger since you’re squeezing the entire amount in a shorter time frame.

The Interest Rate and APR

Most people think that the annual percentage rate (APR) is the interest rate, but it’s not quite the same. As you can see from the name, the APR is a yearly total, and you’ll have to account for the fee on an annual basis.

In any case, both the interest rate and APR will be much higher for unsecured loans. Lenders need something to fall back on in case you don’t pay, as there’s no collateral involved. This can also keep away irresponsible borrowers who find the high rates unappealing.

The Amount You Can Borrow

You’ll be able to borrow more money with a secured loan since you’re giving collateral to the lender. So while it can be uncomfortable to have a big-ticket item (such as your house) at risk, the payoff is you can get a large sum of money to work with.

Conversely, if you only need a relatively small amount of cash, it’s not worth losing your house or car over. Choosing an unsecured loan would be wise in this case.

How You Can Use the Loan

If you want to use the loan on anything you want, then an unsecured loan is best. Usually, lenders don’t have any restrictions on how you use the money. this means you can pay for cosmetic surgery, college books, or even gambling if you want.

Secured loans will be more specific about what you can spend the money on. For instance, an auto loan means you can only spend it on buying a car.

How to Choose the Right Type of Loan

There’s no right or wrong answer as to which loan you should apply for. Instead, there are circumstances that make one better than the other.

Assess Your Situation

First, you need to consider these main things: why you want a loan, as well as what your current financial situation and credit score look like. For example, if you want to buy a house, then getting a mortgage (secured loan) may be the better option.

Also, do you have any collateral; if so, then what? Which ones are you willing to risk (in other words, potentially lose)?

Look at the Loan Terms

There are several parts to a loan that can make some more optimal than others. The main components are:

• Amount
• Interest rate/APR
• Collateral
• Repayment period

You need to add these things together and see what makes financial sense.

For instance, a longer repayment term with lower payments can be an attractive choice, but you’ll end up paying more interest in the long run. As long as you’re aware of this and are comfortable, then it can be better than stressing out about larger payments over a shorter period.

More Tips

No matter what your financial situation is, always borrow only what you need, not what you can get. When people see how much they can get, they become enamored, and max out the loan.

However, this is a bad idea, as you never know what may happen to you financially. The best idea is to only borrow what you’re sure you can pay back.

Also, make sure you’re 100% comfortable with the repayment period. After all, it’s a long-term commitment, and if you have even a little doubt, it can spell trouble in the future.

Know Your Options for Personal Loans

Now you know the difference between secured vs. unsecured loans. As you can see, they’re both personal loans, but each comes with its set of pros and cons.

Knowing detailed information on these loans can help you make a more informed decision. And hopefully, this article has helped clarify things so you can make a confident choice. But of course, if you still have any questions, don’t be afraid to ask a professional for an explanation.

If you need a personal loan, then apply for one with Fast Loan Direct now. We can connect you with the right lender.