Secured Loan vs. Unsecured Loan: What’s the Difference?

Understanding the difference between a secured and an unsecured loan is important when deciding how to borrow, whether you’re paying for something as substantial as a new home or just meeting personal expenditures. Each type of loan has its own rules, benefits, and drawbacks.

Secured loan vs. unsecured loan: Key differences

What is a secured loan?

A secured loan is backed by an asset the borrower owns, known as collateral. If the borrower defaults on the loan, meaning they don’t pay it back as agreed, the lender can take the asset to recover the loan amount. This security allows lenders to offer larger amounts and lower rates, but it makes the loan riskier for the borrower.

The most common types of secured loans are mortgages and auto loans. The former is secured by the property being purchased, the latter by the vehicle being purchased. You may also be able to secure a loan with other assets, including cash in the bank, an investment portfolio, jewelry, fine art, collectibles, and more.

Types of secured loans

Mortgage

A mortgage is a loan for which the home being purchased is the collateral. Mortgages generally have low interest rates, as a home is typically a stable investment. While the industry has had ups and downs, notably the mortgage crisis in 2007 and 2008, real estate increases in value over the long run. This allows people with good credit to obtain lower interest rates compared with other types of loans.

A home equity line of credit (HELOC) is also secured by a home, but it works more like a credit card. You can pay down your balance, and then borrow additional funds up to your account’s credit limit. Interest rates are generally better than other loan types but not as good as those for a traditional mortgage.

Auto loan

An auto loan is a popular method of paying for a car over time. Like a mortgage, the loan is secured by what you’re buying, in this case, a vehicle. As vehicles depreciate in value over time and are at a higher risk of not being paid for than a home, the interest rate on an auto loan is higher than for a mortgage. Still, an auto loan generally costs less than an unsecured loan.

When applying for an auto loan, the best interest rates are typically reserved for borrowers with excellent credit ratings and shorter loan terms. Generally, the longer you take to pay off the loan, the higher the interest rate. If you miss too many payments, the lender can repossess the vehicle to compensate for the loan’s outstanding balance.

Secured personal loan

This is an installment loan secured by a personal asset(s). It typically has a fixed interest rate and payment for the life of the loan.

Many lenders only offer unsecured personal loans. If you can find one with a secured option, you’ll often save compared with an unsecured loan. However, like other secured loans, you'll lose your collateral if you don’t make payments as agreed.

Secured loan pros and cons

What is an unsecured loan?

An unsecured loan doesn't require any collateral. Lenders issue these loans primarily on the borrower's creditworthiness and promise to repay, making it riskier for the lender than a secured loan.

Even with a higher interest rate, the loan is less risky for the borrower, as there’s no chance of losing a valuable asset if you can’t make your payments. This doesn’t mean you can skip paying without consequence, as the lender can still take legal action to make up its losses. But unlike a mortgage loan or car loan, you won’t quickly lose your home or vehicle if you stop paying.

Types of unsecured loans

Personal loan

Depending on the lender's rules, you can use funds from a personal loan for almost anything you want with only a few limitations, such as higher education or starting a business. Unsecured personal loans are popular for debt consolidation, vehicle purchases, home improvement, medical bills, and funding large purchases.

Credit card

A credit card is a very common type of loan, one that many people forget is a loan. Every time you make a purchase with a credit card, the card issuer gives you a small loan to cover the cost. At the end of the month you either have to pay off the balance in full or pay a portion of it plus interest charges based on the remaining balance.

Student loan

A student loan is used to cover the cost of college. It’s typically unsecured and approved based on the borrower's future earning potential. Government student loans are backed by programs that can help you get lower interest rates and other benefits. Private ones are primarily based on the borrower’s creditworthiness and financial situation.

Unsecured loan pros and cons

When is a secured loan better than an unsecured loan?

A secured loan might be better if you need to borrow a large amount or want a lower interest rate. It’s also preferable if your credit history isn’t strong enough to secure an adequate unsecured loan. It’s ideal for large expenses, such as a home or vehicle.

When is an unsecured loan better than a secured loan?

An unsecured loan is better if you want to avoid putting any assets at risk or need funds quickly without the hassle of a lender evaluating your assets. It’s also suitable for those with high credit scores who can qualify for lower rates even without collateral.

Getting a secured loan vs. an unsecured loan

Here's a step-by-step guide for obtaining secured and unsecured loans.

Steps for getting a secured loan

1. Determine your loan needs. Decide how much you need to borrow and how you will use the loan.
2. Evaluate your assets. Determine which assets (such as a home, car, or savings) you can use as collateral. If you’re buying a property or vehicle, it’s generally used as the collateral.
3. Shop around. Compare different lenders to find the best interest rates and loan terms for your type of collateral.
4. Check your credit score. Although secured loans are less dependent on credit scores, a higher score can still get you better rates.
5. Apply for the loan. When you fill out the application, include details about your financial situation and any collateral.
6. Undergo asset evaluation. The lender will assess the value of your collateral to ensure that it covers the loan amount.
7. Close the loan and receive funds. Once approved, you should finalize the loan agreement, offer your asset for collateral, and receive the loan amount.

Steps for getting an unsecured loan

1. Determine the loan amount. Figure out how much money you need and what you will use it for.
2. Check your credit score. Ensure that your credit score is high enough to qualify with favorable terms.
3. Shop for lenders. Focus on lenders offering the best rates and terms.
4. Compare loan offers. Evaluate various lenders' interest rates, fees, and repayment requirements.
5. Apply for the loan. Provide information about your employment, income, and financial history.
6. Await approval. The lender will review your credit and financial information to determine if you qualify for the loan. Some lenders offer instant approval online, while others take a few days to review your application.
7. Receive the funds. Once approved, the loan amount will be deposited into your account, typically within a few business days.

Remember that no loan or lender is right for everyone. Shopping around can help you find the best loan for your needs. For example, LightStream and SoFi are among the best lenders for those with good to excellent credit, while OneMain Financial and Avant are suitable for borrowers with less-than-perfect credit.

TIME Stamped: When it comes to secured vs. unsecured loans, neither is inherently better

Secured and unsecured loans play an essential role in personal finance. Which type you choose will depend on your specific circumstances, including your financial stability, the amount you need, and your comfort with risking collateral. By understanding the differences and weighing the pros and cons, you can make a decision that aligns with your financial goals and needs.

Frequently asked questions (FAQs)

What is better—a secured or unsecured loan?

The answer to this question is neither. Secured and unsecured loans are different. The former may be easier to get if you have lower credit and can’t get approved for an unsecured loan. The latter may have lower costs, but you risk losing your collateral if you don’t pay the agreed-upon loan.

Is it a good idea to get a secured loan?

If you’re confident you can keep up with scheduled payments, a secured loan can be an ideal way to borrow. It’s often the best option for large home and vehicle purchases.

What are the main disadvantages of a secured loan?

The most significant disadvantage of a secured loan is that you lose the collateral securing the loan if you miss enough payments. In addition, the approval process tends to be longer due to the need to evaluate the collateral.