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

 

Are you thinking of borrowing some money from a formal or alternative lender?

If yes, you’re not alone. Every year millions of Americans take out personal loans to help meet various financial needs, from settling utility bills to purchasing big-ticket items such as cars.

When going in for a personal loan, you can apply for a secured loan or an unsecured loan.

Which is the right option for you?

Here’s a comprehensive secured vs unsecured loan guide to help you make an informed decision.

What’s a Secured Loan?

A secured loan is backed by collateral, usually an asset like a car or house title. If the borrower fails to pay off the loan, the lender can seize the collateral and sell it.

There are various types of secured loans. They include:

Auto Loan

When you want to buy a car but can’t afford to pay for it in cash, you can apply for an auto loan. If approved, the lender will write a check to the dealership, and you’ll get the car. However, the car’s title will indicate two owners: you and your lender.

In the event that you’re unable to pay the lender, they can repossess the car.

Home Loan/Mortgage

A mortgage is secured against the property. Like other secured loans, the lender can initiate the foreclosure process should the borrower default on the loan.

Secured Credit Card

If you have poor or no credit, it’s hardly possible to get a regular credit card. This is where a secured credit card comes in handy.

You deposit a certain amount of cash, which also serves as your credit limit. So if you pay a deposit of $500, you will get a card with a credit limit of an equivalent amount.

However, unlike auto and home loans, you have nothing to lose if you can’t settle the credit card balance. After all, it’s your money you were spending! That said, if your intention of getting a secured credit card was to improve your credit history, you won’t have done yourself any favors.

Pawnshop Loans

In the informal lending sector, you can pawn a valuable asset and get some cash in return. Your item will remain at the pawnshop till you pay off the loan, failure to which the shop owner can keep or sell it without your consent.

What’s an Unsecured Loan?

An unsecured loan is the exact opposite of a secured loan. A borrower gets the money without putting up any collateral.

However, just because you don’t need to put up collateral doesn’t mean you’re guaranteed approval. In most cases, lenders will want to ensure that you have a verifiable income or/and a good credit score.

You’re probably wondering, “what leverage does a lender have if the borrower fails to repay an unsecured loan?”

Well, the truth is they don’t have any leverage. However, if you default on the loan, the lender will most likely sell the debt to a collection agency. The debt collector will try to recover the loan and your credit score will take a hit.

There are a number of unsecured loans. They include:

Personal Loan

If you have a regular income, you can approach a lender for a personal loan. The amount you qualify for will depend on your credit, your level of income, and the quality of relationship you have with the lender.

Revolving Loan/Personal Line of Credit

A regular credit card is a good example of a revolving loan or line of credit. A lender approves you for a certain amount of money (credit limit), which you can spend at your own will. You must repay what you’ve spent before the billing cycle ends; otherwise, you’ll incur additional charges.

Payday Loan/ Cash Advance

Payday loans and cash advances aren’t traditional loans, but they qualify to be unsecured loans. As long as you have a job, you can qualify for a payday loan.

These loans are short-term, usually repayable within a month.

Secured vs Unsecured Loan: Which Is Right for You?

Now that you know the difference between secured and unsecured loans, which is right for you? Here are a couple of factors to consider before making a choice.

Purpose of the Loan

What do you intend to do with the money?

If your plan is to spend it on a big-ticket item such as a house or car, it’s advisable to go for a home loan or auto loan. Both are secured loans.

In any case, most big money loans are secured.

On the other hand, if your plan is to borrow money to pay rent or settle a small health bill, a personal, unsecured loan is the right fit.

Do You Have Any Collateral?

If you already own a home or a car, you can use either as collateral for a secured loan. But if you don’t have any valuable asset you can use to back a loan, then you can only take out an unsecured loan.

How Quickly Do You Need the Money?

Most unsecured loan applications are processed quickly, typically by the next business day. In fact, you can apply for this loan online.

Secured loans take several days.

So if you need money urgently, go for an unsecured loan.

Have Your Pick!

When you’re looking to get a loan, you can easily fall into confusion because there are several types of credit products in the market. But with this secured vs unsecured loan guide, you’re now in a stronger position to make a well-informed decision.

Need more financial tips? Keep reading our blog!