Secured and unsecured personal loans differ in terms of risk and cost to both the borrower and the lender. A secured loan, such as a home loan or car loan, is backed by collateral. An unsecured loan, such as a student loan or credit card, has no collateral. Both types of loans are common financial tools — so common, in fact, that the amount of debt resulting from personal loans has created the need for other types of loan products and programs, such as debt consolidation loans and loan reduction or loan forgiveness options.
Knowing how to handle these kinds of debt, compare personal loan rates, and assess loan terms starts with knowing some of the basic differences between loan types. Whether you’re looking for small loans from a bank, online personal loans, private loans or need a loan with the best personal loan interest rate, you need to start by understanding how to choose and apply for a secured or unsecured loan based on your credit history and financial needs. Read on to find out whether a secured or unsecured loan is better for your particular situation.
Jump to the section you want to read:Secured Loans vs. Personal LoansSecured Loans GuideHow to Apply for a Secured LoanUnsecured Loans GuideHow to Apply for an Unsecured LoanBottom Line: Secured Personal Loans vs. Unsecured Personal Loans
Secured Loans vs. Unsecured Personal Loans
A secured loan might be a better fit for someone with less-than-spectacular credit, according to Amanda Abella, a savings advisor for MoneySavingPro.com. “You’d have to show the lender that you can pay back the loan and, if your score isn’t great, then the lender would require collateral like a deposit or a car to ensure that they don’t lose their money,” she said. “As long as you can meet the collateral requirements, you can get approved.”
An unsecured loan, however, can be a better choice for someone with a good credit score. Financial institutions are more willing to take on the risk of an unsecured loan if the borrower has a good to excellent credit score and history. “If you’ve been able to manage credit up until now, then history would suggest you’ll be fine,” said Abella.
The following table shows the basic differences between secured and unsecured personal loans. Details about these loan types are provided below.
|Differences Between Secured and Unsecured Loans|
|Secured Loan||Unsecured Loan|
|Preferred Credit Score||640+ (Fair)||700+ (Good to Excellent)|
|Loan Insurance||Sometimes Required||Not Usually Required|
|Examples||• Car loan
|• Credit card
• Student loan
• Personal loan (e.g. home improvement loan, small loan for vacation)
Credit cards are the most common form of unsecured debt; in 2015, Americans carried $925 billion in debt on credit cards, according to Debt.org, an organization that provides debt-reduction resources. Student loans, another type of unsecured personal loan, can become uniquely burdensome to young graduates with low income because the loans can seem to have no end in sight. And although Debt.org reported that Americans had nearly $100 billion in student debt as of 2015, the Department of Education reported that almost 4 million Americans were enrolled in loan forgiveness or income-driven loan repayment programs in 2015.
Similar to unsecured loan debt, secured loan debt can vary widely by age group and life stage. Median amounts for car and house loans, for example, range from $7,000 for millennials to $195,000 for Generation Xers, according to a 2015 Pew Charitable Trust report on debt in the U.S.
Secured Loans Guide
For borrowers with fair credit scores, secured loans and financing, such as a mortgage or a car loan, can be easier to obtain. The lender assumes less risk because the borrower’s assets are used as collateral, and the interest rates can be lower than unsecured loan rates. For example, a mortgage lender places a lien on the property until the loan is repaid and, if the borrower fails to repay the loan, then the lender can obtain the funds it is owed by seizing and selling the property.
Advantages of Secured Loans
Advantages of a secured loan can depend on your specific financial situation. Some pros of getting a secured loan include the following:
- A secured loan can be less expensive than an unsecured loan. In the case of a mortgage, for example, the asset (the house) might increase in value over time. The interest paid could be partially offset by the increased value of the house, reducing the overall cost of the loan.
- Obtaining a loan can be convenient. Using your existing bank as a source can speed up the loan process because the bank is aware of your income, existing assets and financial habits.
- Secured loans can be easier to obtain if your credit is not great. Because the bank or lender can seize your collateral if the loan is not repaid, there is less risk for the lender.
- Interest paid on mortgage loans and home equity loans can be tax-deductible under certain circumstances.
Disadvantages of Secured Loans
The disadvantages of secured loans involve risk on the part of the borrower. Also, these loans have less of a positive effect on your credit rating than unsecured loans can have, according to Financial Web, an online personal finance educational resource. Other cons of secured loans include:
- You risk losing assets, and the lender risks nothing.
- Even if you dutifully make payments on time, the positive effect on your credit score is minimal. A secured loan on your credit history, such as a savings secured loan that uses your savings account as collateral, can be a red flag to future lenders that you are a high-risk borrower and that you could not qualify for an unsecured loan from another lender, according to Financial Web.
- Secured loans can come with higher fees, including a fee to pay off the loan early.
- You might be required to purchase some type of insurance for a secured loan. For example, private mortgage insurance is designed to protect the lender if you default on the loan or can’t pay a large enough down payment.
How to Apply for a Secured Loan
To get a secured loan, you will need to provide a significant amount of documentation to the lender. Make sure to get an estimate of the interest rate from the lender before you complete the loan application. Most financial institutions offer loan interest and payment calculators to help you research your options and budget for your loan payment. Here is a simple breakdown of how to get a personal loan that is backed by collateral.
1. Check Your Credit Report
Before applying, check your credit report with the three credit bureaus — Equifax, Transunion and Experian — to see if you need to address any issues such as poor payment history, too high of a debt-to-income ratio, or fraud stemming from identity theft. If you find any red flags or errors, contact the credit bureaus to have the items corrected. You can make your credit history more attractive to lenders by paying down debt and paying bills on time in the months before you will need to complete the loan application.
2. Check Your Credit Score
Information on your credit report such as your payment history is used to determine your credit score. Your score needs to be at least 640 or above to qualify for a secured loan with a reasonable interest rate. A poor FICO credit score can prevent you from qualifying for credit or a loan or can limit you to only qualifying for loans with higher interest rates.
3. Gather Necessary Documents
Collect documentation, such as pay stubs, to show the lender that you have a stable income. You will also need basic personal information, such as your ID and address.
4. Determine How Much Money You Need
Decide how much you need to borrow. A larger down payment can potentially help you qualify for better loan terms. For a secured loan, the lender will require a note as collateral, such as a house or car title.
Pay attention to details about the loan terms. An amortizing loan, for example, is a loan that applies monthly payments to both the interest and principle. Some mortgages, however, are structured so that you only make payments on the interest for a specified number of years, after which you can then make payments or a lump-sum payment for the principal.
5. Compare Lenders
Choose a lender. If you already have a good relationship with a bank, you might be approved for a loan more quickly because the bank knows your financial history. Some local and online financial institutions might be able to offer you a more competitive loan rate, however, so compare rates and terms before making a decision.
6. Fill Out a Secured Loan Application
Make sure you meet the qualification requirements before applying for a secured loan. If you do not meet the requirements and your loan application is denied, your credit rating could suffer, making it harder for you to qualify for a loan in the future. Get an estimate of the loan rate and monthly payment amount and make sure your budget can handle it before you submit the application.
Some financial institutions — particularly ones where you are already a customer — can process secured loan applications in as little as a few hours. Others can take up to 10 days before depositing the amount of the loan into your account.
7. Make Your Loan Payments on Time
Make your loan payments on time to avoid damaging your credit score and to establish a good credit history. By building a strong history of responsible credit use and loan payments, you can potentially qualify for better interest rates and loan terms in the future.
Unsecured Loans Guide
Unsecured loans are sometimes referred to as signature loans because the lender is accepting the borrower’s signature — and a good to excellent credit score — as a promise to pay rather than requiring collateral. These loans can be obtained for small amounts of around $1,000 up to tens of thousands of dollars. Bank loans and unsecured loans from online financial institutions are typically used for a range of purchases and expenses like vacations, home renovations and medical bills and paying off other debt.
If you default on the loan, the lender can sue you to collect the funds. Because a lawsuit takes time and can be expensive — and because lenders are assuming more risk when granting unsecured loans — banks and other lenders charge higher interest rates for unsecured loans than for secured loans.
Advantages of Unsecured Loans
Pros of unsecured loans — particularly if you have a higher credit score — include:
- You are not at risk of losing assets because the loan doesn’t require collateral.
- An unsecured loan might have a shorter repayment term, which can result in fewer interest payments and a lower overall loan cost.
Disadvantages of Unsecured Loans
If you do not have a good credit rating, you might be considered high risk. Loans for high-risk borrowers can be more expensive. Other cons of unsecured loans for borrowers with less-than-stellar credit scores include:
- It can be harder to obtain an unsecured loan from a lender, who must assume the bulk of the risk.
- You might be limited in the amount you can borrow based on your creditworthiness.
- The interest rate can be high because of the amount of risk that the lender must assume.
- The interest on the loan cannot be deducted on taxes.
- Borrowing might involve application fees, monthly fees and penalties for paying off the loan early.
Payday Loans Are Expensive Unsecured Loans
Payday loans and online payday loans are examples of no-credit-check personal loans that are typically made available to people with bad credit. These unsecured loans are sometimes short-term cash loans, like a cash advance on your paycheck or another deposit.
They are usually granted for small amounts between $100 and $1,000 and can carry interest rates in excess of 400 percent, according to the Consumer Financial Protection Bureau. Fees of between $10 and $30 are typically required for every $100 borrowed.
How to Apply for an Unsecured Loan
Unsecured loan application requirements can vary depending on the type of loan. For example, you might need to supply specific information unique to a private student loan application compared with a credit card application. The basics of how to apply for an unsecured loan are generally the same, however.
1. Check Your Credit Score
Check your credit score. You should avoid applying for an unsecured loan if your score is not high enough to qualify. Some lenders required a score of at least 680, whereas others require a score above 700.
“Without the proper credit rating, you are not likely to obtain such a loan and might have to consider seeking a secured loan instead,” said Byron Ellis, a certified financial planner with United Capital Financial Advisers in Newport Beach, Calif. “Typically, a lender will carefully review the five C’s of your credit: character, capital, collateral, capacity and conditions. This will give the lender the confidence they need to loan you the money without having to fear they will not be paid back.”
2. Improve Your Credit Score If Necessary
Pay bills on time and pay down debt before you apply for an unsecured loan. If you are denied a loan, your credit score might decrease further. You also can check your credit report for errors and issues that might be lowering your score.
3. Compare Traditional and Online Lenders
Shop around and compare persona loan rates between banks, credit unions and other financial institutions. Check to see if you qualify for personal loans online because online lenders usually have lower overhead costs than brick-and-mortar banks and might offer you a lower interest rate.
4. Calculate How Much Money You Need to Borrow
You will need to state how much you want to borrow and when you will pay it back. Borrow only what you need. Prepare a budget and plan to pay back the loan as soon as you can to reduce the amount of interest you’ll pay over the life of the loan.
5. Fill Out an Unsecured Loan Application
Make sure you understand the loan terms before you fill out an application. Using a bank that already knows you can make the process easier and quicker because the lender already knows your credit history. Some banks offer more favorable interest rates to loyal customers.
Submit your application. The lender will need your Social Security number and ID. You might need to provide proof of your address in the form of a recent utility or similar bill. A lender will want to see your pay stubs to check your income and will ask you to disclose any debt that you currently hold, such as car loans or student loans.
6. Check Your Loan Application Status
Once your application is complete, the bank will process your information. Some loans can be processed in one day; others can take up to a month. Your lender can tell you how long it might take for the funds to be deposited into your account.
Bottom Line: Secured Personal Loans vs. Unsecured Personal Loans
Here is the bottom line if you are still unsure about which loan might be best for you:
A secured loan is tied to collateral, such as a house or a car. The lender can seize the property if you fail to pay back the loan. The advantage of a secured loan is a lower interest rate than an unsecured loan rate because the risk is on the borrower who is providing the collateral. These loans generally have longer term lengths than unsecured loans, however. If you have a fair credit score, have collateral and are confident you can pay back the loan, then this is typically the best personal loan option.
An unsecured loan is not backed by assets. The interest rate is typically higher than a secured loan rate because the risk is on the lender, who potentially gets nothing if the loan is not repaid. Credit cards, small personal loans and student loans are examples of unsecured loans. If you have a good credit score or someone with a good to excellent credit score can cosign the loan for you, then you can qualify approved for an unsecured loan.
For any type of loan, you need to compare various lenders and loan companies’ offers and terms to find the best personal loan rates. You might need to compare interest rates from national, local or regional, and online lenders before you find the right loan for you.