Secured vs Unsecured Loans
Borrowing money can be scary, especially if you aren’t clear on what type of loan you need. Understanding the difference between a secured vs unsecured loan is essential if you hope to make an informed, educated decision about the best loan for your needs and financial goals.
Unsecured and secured loans each have specific nuances, benefits, and risks you should be aware of, and we’re addressing them all here. Secured loans, which “secure” the amount you borrow by requiring collateral in case you don’t repay, offer a guarantee to the lender or creditor. Think of unsecured loans as credit cards, some personal loans, or student loans.
Keep reading to learn valuable insights about different types of loans and what the pros and cons of secured personal loans and unsecured loans are. Learn everything you need to know about whether a personal loan, secured, or unsecured loan is the best option for your lending needs.
What are Secured Loans?
Secure loans require borrowers to use collateral as a guarantee they’ll repay the amount they borrowed. Typical collateral might be an asset like a vehicle, property, or cash in a savings account. Offering a guarantee gives lenders confidence that borrowers will return the money they’re loaned. If they fail to do so, the creditor has a way to recoup their money.
Advantages of secured loans
There are multiple benefits to secured loans.
- Lower interest rates – Because lenders assume less risk since they have a guarantee to rely on, they can offer more attractive interest rates.
- Longer repayment terms – Secured loans usually have longer repayment terms, which gives you more time to pay off your debt and can reduce monthly payment amounts.
- Higher loan amount – Since they’re backed by collateral, you might be able to access a higher loan amount when you use a secured loan.
Examples of secured loans
There are many secured loan examples that can help you better-understand this loan-type.
- Mortgage loans – When you purchase or refinance a home, a mortgage loan offers the significant funds you’ll need. The collateral on a mortgage is the property itself. If you fall behind or default on your loan repayment terms, the lender can foreclose on the property.
- Auto loans – Similar to a mortgage loan, auto loans will provide you with the money you need to purchase a vehicle. If you don’t repay an auto loan, the vehicle will be repossessed.
- Personal loans secured by savings – Sometimes lenders offer personal loans secured by a savings account or certificate of deposit (CD). These loans can be an alternative for borrowers with a substandard credit history or no income documentation.
- Secured credit cards – For people with little, no, or bad credit history, a secure credit card can be a great way to access money and start building (or rebuilding) your credit. These cards require a “deposit” (or a fee) to get the card.
Risks associated with secured loans
Secured loans can be an excellent option for people with risky or no credit, but they also come with their own risks. Understanding these potential pitfalls is essential before you choose the secured loan option.
- Loss of collateral – If you default on your loan repayment, you will lose your collateral. Lenders have a legal right and claim over whatever asset is used for collateral.
- Difficulty in obtaining a loan if collateral has little value – Collateral must be high value for it to be security for the lender. If a lender doesn’t feel they could recoup their investment based on the collateral you’re providing, it will limit your options for accessing a loan.
What are Unsecured Loans?
Unsecured loans do not require collateral, making them easier to get with less paperwork. That said, they generally have a higher interest rate due to increased lender risk.
Advantages of Unsecured loans
Unsecured loans can offer multiple advantages.
- No collateral required – The most obvious advantage to an unsecured loan is you do not need any collateral to apply. This means you can access funds without risking property or valuable assets in your portfolio.
- Quicker and easier application process – An unsecured loan application and the approval process tend to be much quicker than secured loans.
- Access to funds in emergency situations – Because the process is fast and easy, this type of loan can be ideal for emergencies or when you need cash fast.
Examples of Unsecured loans
Here are some common examples of unsecured loans.
- Personal loans – A personal loan can be used for any purpose, including debt consolidation, home improvements, education expenses, or vacation. Personal loans generally have a fixed repayment term and interest rate.
- Credit card loans – Some credit cards offer unsecured financing. They allow you to make purchases and pay off the balance over time. Note that you’ll be charged interest on any outstanding balance that carries over longer than one month.
- Payday loans – Payday loans are short-term loans that offer an advance on cash at an extremely high-interest rate. Though they’re technically not secured loans, the high-interest rate or fee associated with them makes them less than ideal for borrowers. Most financial advisors and experts warn against using payday loans.
Risks associated with Unsecured loans
Like anything, there are risks and disadvantages associated with unsecured loans.
- Higher interest rates – Unsecured loans can have higher interest rates since lenders take more risk by offering funds with no guarantee of repayment.
- Shorter repayment terms – Again, due to risk, unsecured loans can have shorter payment terms, as lenders want their money back as quickly as possible.
- Lower loan amount – Since there isn’t collateral involved, the maximum loan amount typically will be lower than what you might borrow through a secured loan.
- Increased risk of default – Because some people who try to secure unsecured loans have a risky credit history or low credit score, there is a higher risk of default on this type of loan.
Factors to Consider When Choosing Between Secured and Unsecured Loans
What is the difference between a secured and unsecured loan? Deciding between a secured vs unsecured loan can be difficult, but understanding the following will help.
- Purpose of the loan – The purpose for your loan will be a significant factor in your decision-making process. Do you need funds for debt consolidation? Do you want flexibility with how you use the money? Are you looking to make home improvements? Unsecured loans might be a good option in these instances. That said, a secured auto loan or mortgage can make much more sense if you’re purchasing an asset like a car or house.
- Credit score – Your credit score will play a big role in the type of loan you get and the terms you’ll need to abide by. The worse your credit is, the higher the likelihood you’ll have a high-interest rate, ultimately costing you more to borrow money.
- Available collateral – If you don’t have any valuable collateral, a secured loan may not be feasible.
- Ability to repay – Your ability to repay a loan will be a big determiner in the type of loan you get. Only borrow what you can afford to pay back – this sounds like common sense but is often overlooked.
- Urgency of need for funds – Remember that secured loans can have a longer approval process since lenders want to assess collateral value before approving a loan. If you urgently need funds, an unsecured loan can be quicker.
Choosing between a secured vs unsecured loan will ultimately depend on what you need the money for, how quickly you need it, and other factors like your credit standing and the loan amount.
If you’re looking for a reliable and secure lender who offers secured and unsecured loans at competitive rates, check out HFS Federal Credit Union today. We are committed to providing you with personal guidance and assistance throughout the loan application process, so you can trust you’re getting the best type of loan, at the best rate possible, making your money work for you.