What are the Differences between Secured and Unsecured Loans?

A loan is classified as either secured or unsecured, which refers to whether or not you put up assets or collateral to guarantee the loan. With a secured loan, you guarantee the lender that they will be repaid by giving them access to something that you own. The lender has a right to seize the collateral or asset to recover their investment. Lenders derive a lot of security from this guarantee and it enables them to reduce their interest rates.

An unsecured loan does not require any form of security from the borrower. This means the lender does not have any protection if they are not paid back. Unsecured loans usually have high interest rates. Financial institutions may require a cosigner for an unsecured loan or an additional person who can commit to repaying the loan in case the borrower does not. One of the advantages of student loans is that they come with low interest rates despite having no requirement for collateral.

Everyone is likely to borrow money during their lifetime. Many people borrow money to purchase a car or house. Individuals take out personal loans to cover expenses or purchases. Even a credit card is a way to borrow money.

When you make the decision to borrow money, you need to have a clear understanding of how loans work and the types of loans that are available as well which loan is right for you and how much it costs. One of the main differences between loans is whether they are secured or unsecured.

Secured loans

Secured loans are basically secured or guaranteed by collateral or an asset. Auto loans and mortgages are among the common options for secured loans. An auto loan would be secured through the vehicle while a mortgage loan is secured through the house that is funding.

There is a lower risk for lenders when loans are secured by assets because if a borrower does not make loan payments or defaults, the asset can be seized by the lender to recoup some of the money by selling the asset.

How secured loans work

The lender retains the deed or title when items such as cars or houses are used to guarantee loans. Lenders can keep these assets until the principal amount, interest and other fees are fully paid. At this point, the deed or title is given to the borrower, who now has complete ownership of the asset.  

Advantages of secured loans

Since the risk for the lender or bank is lower, a secured loan usually comes with higher limits for borrowing, lower interest rates and longer terms in comparison to unsecured loans.

Disadvantages of Secured Loans

Secured loans may take a longer time to obtain and process because of the inclusion of collateral. This is why some consumers choose unsecured loans that they can use on a short-term basis such as funds for medical costs or home renovations.

Collateral

Collateral refers to the asset that is used as security for a loan. Real estate and cars are among the common items that can be used to guarantee loans. Personal valuable property, investment accounts, stocks and bonds are other types of assets that can be used.

Home equity loans and lines are secured loans because the equity in the home or difference between the balance of the home loan and value of the property is used to back the loan. Other secured loans include loans for recreational boats and vehicles.

Qualifying

A proven source of income and a good credit score are essential for qualifying for any type of loan but since a secured loan is backed by an asset, it can be easier to get a secured loan in comparison to the unsecured option.

Unsecured loans

Unsecured loans are the opposite of secured loans because they are not secured by any asset. Typically referred to as personal loans, these are also known as signature loans due to the guarantee given through a borrower’s signature.

In many cases, all the borrower has to do is sign the loan agreement and promise to pay back the loan and interest in installments according to the agreement. After the paperwork is completed, the borrower is given the money.

Advantages of unsecured loans

Personal or unsecured loans can be used for any purpose and the amounts vary. Many lenders and banks provide substantial personal loans of large amounts. However, certain amounts usually require collateral if they exceed a certain figure.

Personal loans can be simple ways to fund anything like a vacation, home improvements or a purchase, especially if your credit is favorable. They can be used to consolidate debt, pay tuition, pay taxes or virtually anything else. Since they are not guaranteed by assets, unsecured loans often come with interest rates that are higher than those of secured loans.

Unsecured loans include student loans, credit cards and personal loans.

 Disadvantages of unsecured loans

Since unsecured loans are riskier for lenders, higher interest rates can be charged, which means you will be required to pay more during the life of the loan. High interest loans lead to higher loan payments that can be harder to afford.

Unsecured loans may be challenging to qualify for. If you have a non-existent or poor credit history, the lender might not approve your loan application.

Qualifying

A personal loan is not the right choice for everybody. Credit scores are usually expected to be higher for an unsecured loan than a secured one. It is important to note that lenders who focus on giving loans to people who have bad credit can be detrimental. If a borrower does not make payments, the penalties and high interest rates can result in a terrible financial situation.

Secured and unsecured loans

Different circumstances determine whether a secured or unsecured loan should be taken. A personal loan is useful for taking the next step when you require extra cash. You can find different loans and lenders, whether you need money for home renovations or to buy a car.

If you want to buy an asset or have one, you may have encountered terms such as secured and unsecured while exploring the options that are available for loans. The main difference between these loans is that you need to provide assets for collateral when dealing with secured loans and this is not a requirement for unsecured loans.

The lender usually repossesses assets and sells them to recoup losses when borrowers default on their secured loans. The assets are typically the ones that you are buying with the funds that are borrowed from the lender, such as a home or car, but they can also be assets that people already own.

The lender usually only has the option of suing you to get back the money they are owed if borrowers default on their unsecured loans.

Both secured and unsecured loans are effective ways to fund a new purchase but you can identify the better option by making comparisons between them. Some of the aspects you should consider include the loan amounts, interest rates, fees, credit, repayment terms and how the funds can be used 

Choosing a loan

If you are not sure about the kind of loan you should get, the following are some of the factors that you can consider:

• Buying a car – The type, cost and age of a vehicle will determine whether a secured or unsecured loan is ideal. Some lenders are strict when it comes to accepting vehicles as guarantees and only accept new cars.
• Using the loan – For secured loans, there may be limitations regarding how the loan may be used.
• Repayments – If you choose a secured loan, the lender can repossess the asset if you are unable to keep up with the repayments. The interest rate will probably be higher for an unsecured loan, which leads to costly repayments.
• Fixed and variable rates – It is important to make comparisons between different options before applying for a loan.