While some people swear by a cash-only lifestyle, the truth is most of us rely on credit to pay for life's big expenses over time. When you want to buy a big-ticket item like a house or a car, open or grow a business, renovate a kitchen or pay for college, you can apply for a loan at either your local back or online to help you cover the cost.
When considering your credit options, you might have to decide between a secured and unsecured loan. Secured loans require that you offer up something you own of value as collateral in case you can't pay back your loan, whereas unsecured loans allow you borrow the money outright (after the lender considers your financials).
There are pros and cons to both types loans, so before you decide anything it's best to understand the strings attached.
What is a secured loan?
A secured loan is a loan backed by collateral. The most common types of secured loans are mortgages and car loans, and in the case of these loans, the collateral is your home or car. But really, collateral can be any kind of financial asset you own. And if you don't pay back your loan, the bank can seize your collateral as payment. A repossession stays on your credit report for up to seven years.
When you take out a secured loan, the lender puts a lien on the asset you offer up as collateral. Once the loan is paid off, the lender removes the lien, and you own both assets free and clear.
Here are the kinds of assets you can use as collateral for a secured loan, according to Experian:
- Real estate
- Bank accounts (checking accounts, savings accounts, CDs and money market accounts)
- Vehicles (cars, trucks, SUVs, motorcycles, boats, etc.)
- Stocks, mutual funds or bond investments
- Insurance policies, including life insurance
- High-end collectibles and other valuables (precious metals, antiques, etc.)
Secured credit cards, such as the Capital One Platinum Secured Credit Card (see rates and fees) and the Platinum Secured Mastercard® from First Tech Federal Credit Union , are another example of a secured loan. The collateral, in this case, is the cash you put down (often a $200 refundable deposit) that acts as your initial credit limit. You get your deposit back when you close the account.
Because your assets can be seized if you don't pay off your secured loan, they are arguably riskier than unsecured loans. You're still paying interest on the loan based on your creditworthiness, and in some cases fees, when you take out a secured loan.
Don't miss: The best secured credit cards of October 2020
What is an unsecured loan?
An unsecured loan requires no collateral, though you are still charged interest and sometimes fees. Student loans, personal loans and credit cards are all example of unsecured loans.
Since there's no collateral, financial institutions give out unsecured loans based in large part on your credit score and history of repaying past debts. For this reason, unsecured loans may have higher interest rates (but not always) than a secured loan.
Unsecuredpersonal loansaregrowing in popularity. There are roughly 20.2 million personal loan borrowers in the U.S. according to the online lending marketplaceLending Tree. You can take out a personal loan for nearly any purpose, whether that's to renovate your kitchen, pay for a wedding, go on a dream vacation or pay off credit card debt.
Most people get personal loans for debt consolidation, and since personal loans tend to have lower APR than credit cards, borrowers can often save money on interest.
What to know before you take out a loan
Before you take out a personal loan, whether it's secured or unsecured, make sure you have a clear payoff plan.
As a general rule, only borrow what you know you need and can afford to pay back. Make sure you are comfortable with the repayment timeframe. Just because you can get a loan doesn't mean you should, so take your time and do your research before you sign on the dotted line.
Learn more: 10 questions to ask before you take out a personal loan
Information about the Platinum Secured Mastercard® has been collected independently by Select and has not been reviewed or provided by the issuer prior to publication.
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
FAQs
Loans may be secured or unsecured. Secured loans require some sort of collateral, such as a car, a home, or another valuable asset, that the lender can seize if the borrower defaults on the loan. Unsecured loans require no collateral but do require that the borrower be sufficiently creditworthy in the lender's eyes.
What is the main difference between secured and unsecured loans? ›
A secured loan is backed by collateral, meaning something you own can be seized by the bank if you default on the loan. An unsecured loan, on the other hand, does not require any form of collateral. Both types of personal loans have their pros and cons.
What is the difference between a secured loan and an unsecured loan quizlet? ›
What is the difference between a secured and unsecured loan? Secured loan uses collateral (i.e. car or house) where unsecured does not use collateral (loan made just on promise to pay it back). Secured loans are usually larger with lower interest rates. Unsecured are usually smaller with higher interest rates.
What is the difference between secured and unsecured loan notes? ›
An unsecured note is not backed by any collateral and thus presents more risk to lenders. Due to the higher risk involved, these notes' interest rates are higher than with secured notes. In contrast, a secured note is a loan backed by the borrower's assets, such as a mortgage or auto loan.
What is the difference between interest rate of secured and unsecured loans? ›
Unsecured loans tend to charge higher interest rates than secured ones because the lender is taking a greater risk. However, the higher your credit score, the lower the interest rate you may be eligible for.
Is unsecured or secured better? ›
Unsecured credit cards tend to come with better perks and rewards, lower fees and lower interest rates. Generally speaking, unsecured credit cards are a better deal for consumers.
What is meant by unsecured loan? ›
An Unsecured Loan is a loan that does not require you to provide any collateral to avail them. It is issued to you by the lender on your creditworthiness as a borrower. And hence, having an excellent credit score is a prerequisite for the approval of an Unsecured Loan.
What is the difference between a secured and unsecured business loan? ›
Small business loans can be secured or unsecured. Secured loans require collateral to back your loan. Unsecured business loans do not require any collateral. Lenders may offer one or both of these small business loan options, each with advantages and disadvantages.
What is an example of a secured loan? ›
Mortgages, home equity loans and auto loans are all common examples of secured loans. In the case of a mortgage or home equity loan, your house is the collateral that secures the loan. In an auto loan, it's your car.
Is a payday loan secured or unsecured? ›
Payday loans are considered a form of “unsecured” debt, which means you do not have to give the lender any collateral, or put anything up in return like if you went to a pawn shop.
The main advantages of an unsecured loan include:
- You don't have to leverage any of your assets to secure funds.
- Your loan approval may be completed faster because there are no assets to evaluate.
- Unsecured loans may be a better option for borrowing smaller amounts.
You should avoid using a personal loan to pay for college tuition, investments, basic living expenses, vacation, discretionary purchases and gambling, as well as a down payment and the costs associated with starting a business.
Are unsecured notes risky? ›
Unsecured notes, on the other hand, are generally riskier than unlisted debentures as there is no tangible property provided as security for investors.
What is the difference between secured and unsecured loans? ›
Secured loans require some sort of collateral, such as a car, a home, or another valuable asset, that the lender can seize if the borrower defaults on the loan. Unsecured loans require no collateral but do require that the borrower be sufficiently creditworthy in the lender's eyes.
Can a secured loan be written off? ›
Most people have a loan secured by property, such as a mortgage or a car loan. These debts, called "secured debts," can be tricky in Chapter 7 bankruptcy. Although you can wipe out or "discharge" a secured loan in Chapter 7 bankruptcy, you'll lose the property you purchased if you don't pay for it after bankruptcy.
Are secured loans worth it? ›
A secured loan can help you build credit if you make all payments on time, but since secured loans are backed by collateral, there is risk involved. Other credit products could help you build credit without as much risk.
What is the difference between a secured and unsecured creditor? ›
Secured creditors are first in the payment hierarchy, followed by unsecured creditors. A secured creditor has a charge over a particular asset or a set of changing assets. Unsecured creditors don't hold a charge and receive money should there be some available once the above creditors have been paid.
What happens if you don't pay back an unsecured loan? ›
Defaulting on an Unsecured Loan
As mentioned previously, however, a collection agency may try to sue you for the unpaid amounts you owe, attempt to garnish your wages, or place a lien on your home through a court order. 5 And, as with a secured loan, you can expect a serious impact on your credit score.
