If you are looking to take out a personal loan, it’s important to understand the difference between a secured vs. unsecured loan. In this article, our financial pros explain these two types of personal loans so that you can make the best decision for your immediate money needs.
Key Takeaways:
- Understanding secured vs. unsecured loans
- The defining characteristics of unsecured personal loans
- The defining characteristics of secured personal loans
- The benefits of choosing a secured loan
- How to choose the right type of personal loan for your needs
Understanding Personal Loans
A personal loan is a lump sum of borrowed money you can repay in installments over time. Personal loans have different monthly payment amounts, interest rates, and repayment terms based on your credit and financial history.
How Personal Loans Work
You can use a personal loan for various purposes, such as car repairs, home upgrades, monthly bills, school supplies, tuition, and holiday expenses.
Personal loans can essentially be used for whatever you need or want, and they're a valuable financial tool for building your credit if you repay your loan according to the terms. Even people with bad credit may be able to qualify for personal loans and get quick access to cash for urgent needs.
Secured vs. Unsecured Loan: Key Differences
The key difference between a secured loan vs. unsecured loan is collateral. Secured loans require an asset to be named that you must forfeit to the lender if you fail to repay the loan. In contrast, unsecured loans do not require collateral, but if you miss payments, your credit score will drop, and a collections agency may pursue you.
What are the Types of Personal Loans?
Various types of personal loans are available to people who need to borrow money. Types of personal loans include unsecured, secured, and specialized loans like payday and peer-to-peer loans. Understanding the differences is crucial for borrowers to make informed financial decisions.
What is an Unsecured Personal Loan?
Let's first answer the question, "What is an unsecured personal loan?" and then explore why you might want this type of loan.
Definition
An unsecured personal loan is a personal loan that does not require you to offer something for collateral. Therefore, a lender cannot take possession of any of your belongings if you don't pay your loan. However, not making payments will harm your credit score and make it harder to get approved for credit.
Characteristics
- No collateral required
- Higher interest rates compared to secured loans
- Typically, smaller loan amounts
- Shorter repayment terms
- Need a strong credit score to get the best offer
Typical Uses
People choose unsecured loans for many reasons, such as handling emergency expenses or debt consolidation. Since there are few restrictions on how you can use an unsecured loan, you might also use this type of personal loan for a vacation, moving expenses, a wedding, or a home improvement project.
Eligibility Criteria
Lenders look at several factors to qualify for an unsecured personal loan, including your credit score and income. Other possible factors are your debt-to-income ratio, credit history, work experience, and college education.
You’ll have the best chance at qualifying for an unsecured loan if you have a good credit score of 690 or higher.
What is a Secured Personal Loan?
So, now, what is a secured personal loan, and how does it differ from an unsecured loan?
Definition
A secured personal loan requires collateral, such as a home, vehicle, or investment account. Although this may sound risky, you may be able to get a lower interest rate or a larger loan if you commit to putting up collateral and making your payments on time.
Characteristics
- Lower interest rates than unsecured loans
- Less risk for lenders
- Larger loan amounts possible
- Longer repayment terms often available
- Credit may still suffer from missed payments
Typical Uses
You can use a secured personal loan for pretty much any purpose, including major purchases for a home, car, furniture, and appliances. Mortgages, home equity loans, and automobile loans are examples of secured loans backed by collateral.
Eligibility Criteria
Lenders will review your creditworthiness to determine the value of the collateral required. Qualifying for a secured personal loan is generally easier than an unsecured one. Adding collateral into the loan terms reduces the lender's risk as they consider your credit history, credit score, income, and other debts.
Benefits of a Secured Loan
There are distinct benefits of a secured loan vs. an unsecured loan. Here are some examples to consider before making a significant financial decision.
Lower Interest Rates
Collateral reduces a lender’s risk, which allows the lender to offer lower interest rates. With a lower interest rate, you can save money over time. Some lenders provide potential APR discounts of 20 percent with a secured vs. unsecured loan.
Higher Borrowing Limits
Secured loans often allow for larger sums of money that you can borrow. This is helpful if you have a major purchase in mind that you can’t afford with your current income or savings.
Improved Approval Chances
Collateral has the power to improve the likelihood of loan approval. Due to less stringent eligibility requirements, you may be able to get a secure loan even if your credit score is low.
Potential for Building Credit
When you take out a secured loan, you can use this opportunity to boost your credit score. Making timely payments can positively affect your credit score so that you can qualify for future credit offers and have more flexibility in your finances.
Flexible Repayment Options
Another of the benefits of a secured loan is greater flexibility in how you can pay back your loan. Although the rates and monthly payments vary, secured personal loans can be repaid in monthly installments over typically two to seven years.
Be Sure to Choose the Loan that's Right for You
We hope that you now have a solid understanding of secured vs. unsecured loans and how collateral plays a key role in distinguishing one type of loan from the other. Both types of personal loans have their unique advantages and disadvantages. So, you will have to see what you qualify for and decide whether you are willing to risk your personal property for a lower APR and larger loan amount.
If you're unsure if a secured vs. unsecured loan is best for you, it may be worthwhile to consult with a financial advisor or multiple potential lenders to learn about their rates, loan amounts, and APRs for each type.
Learn more about personal loans and the available options on Service Loan South’s website. We’ve made the online application process simpler and faster than ever before and have been helping families make ends meet since 1974.
To apply for a loan today, enter your zip code and choose the location nearest you.
