What Is the Difference Between Secured and Unsecured Loans?
Personal loans come in two distinct flavors – secured and unsecured – and the one you choose will make a big difference in how much you can borrow and how much interest you pay.
The difference between secured and unsecured loans, in a word, is collateral.
Secured loans require borrowers to put up a tangible asset, such as the home or vehicle they’re purchasing. That’s called collateral.
Unsecured loans don’t require it, and since they’re only backed by the borrower’s creditworthiness, their interest rates can be higher.
What Is a Secured Loan?
The collateral in a secured loan gives the lender something to cover at least some of its losses if the borrower defaults. Creating that security makes home mortgages possible – and without mortgages, very few people would be able to afford America’s real estate prices. And most would balk at new car prices since they seldom keep large reserves of cash in their bank accounts.
Secured loans make big-ticket items affordable, and the ability to seize the item being purchased if the loan goes into default, makes these loans worth the risk for lenders, which helps keep interest rates down. Car loans tend to have higher interest rates than home loans because the value of the collateral – your car – decreases with time. If a lender takes the collateral, it might not be worth enough to cover what’s left on the loan. A higher interest rate helps offset that risk.
This creates several differences for the borrower.
- Qualifying can be difficult: Repossessing a car or foreclosing on a house can take time, and the condition of the collateral is never certain, so lenders want to know a lot about a borrower’s income and credit history before issuing a secured loan.
- You can borrow more money: Typical collateral for a secured loan is a high value item, such as a home or car, therefore you can usually qualify for a larger sum of money for a secured loan.
- Longer repayment schedule: Repayment schedules for secured loans tend to be five years for a car loan, and the most popular home loan is the 30-year mortgage.
Common Types of Secured Loans
- Home Mortgage
- Home Equity Line of Credit
- Car Loan
- Loans made by pawn shops
Where to Get a Secured Loan
Banks, credit unions and many online lenders offer secured loans.
Advantages of Secured Loans
- Lower interest rates
- Larger amounts of money available
- Longer repayment schedules
- You can improve your credit score by making consistent, on-time payments toward secured loans
Disadvantages of Secured Loans
- If you fail to make payments, you can lose the collateral: your home or vehicle.
- If you fail to make payments, your credit score will tumble 100 points or more.
- Typically, secured loans are for specific purchases like a home or car
What Is an Unsecured Loan?
The other type of debt, “unsecured loans,” are even more common. High risk loans don’t require collateral, so the lender is taking a very big risk. He’s accepting the word of the borrower that the loan will be repaid. If the borrower defaults, the lender might try to take the borrower to court and get a lien against his property, but otherwise it’s hard to collect a debt.
Credit cards are the biggest source of unsecured borrowing. More than 160 million U.S. households use credit cards with an average debt of $8,900 per household. The nation’s total credit card debt was $986 billion at the start of 2023, according to the Federal Reserve.
Borrowers will see a couple of differences with unsecured loans:
- Loan amounts are smaller: With the exception of student loans, the size of an unsecured loan is often much smaller than secured ones and the amount of interest charged on balances due is usually much greater.
- Interest rates are higher: Interest rates on unsecured loans tend to be significantly higher. The average credit card interest rate over the past several years ranges from 16-19%, while payday loans can cost you 300%-500%.
Common Types of Unsecured Loans
- Credit Cards
- Student loans
- Personal Loans
- Payday Loans
With credit cards, you can buy things today as long as you repay the card issuer when you get a bill. If you don’t repay the full balance when the bill is due, high interest rates kick in and it becomes very costly for the card owner. Student loans that go into default become a negative mark on a consumer’s credit report, until the consumer resumes regular payments.
Where to Get an Unsecured Loan
As with secured loans, financial institutions such as banks, credit unions and online lenders provide unsecured loans.
Advantages of Unsecured Loans
- Unsecured loans are convenient, and usually easy to qualify for. They can help you buy things and make payments when money is short.
- Unsecured loans, when paid on time each month, can help you improve your credit score and eventually qualify for lower interest secured loans.
- Lenders will have to get a court’s approval to take your possessions if you default on the loan.
Disadvantages of Unsecured Loans
- Higher interest rates mean paying significantly more for goods and services than you would otherwise spend.
- Missing payments will harm your credit score.
- You may have a hard time qualifying with bad credit
- Defaulting on the loan can cause serious credit damage, making it hard to borrow for several years.
What Are the Differences Between Secured Loans and Unsecured Loans?
The choice between an unsecured and secured loan impacts your approval chances, your rates and fees, borrowing limits and the need for collateral.
A secured loan gives the lender the right to seize the asset you use as collateral if you default on the loan. Although no assets are required with an unsecured loan, there are credit implications, if you fail to make your loan payments. Lenders can’t seize an asset to compensate for an unsecured debt gone bad, but they can put a lot of pressure on borrowers. Taking the consumer to court and getting either a property lien against them or garnishing wages are ways they can collect unpaid debts.
Due to the financial approval requirements, secured loans tend to have higher borrowing limits, giving you access to more money. The collateral also makes lenders more willing to loan larger amounts since there is less financial risk.
Borrowers has more incentive to repay a secured loan to avoid losing the house or vehicle they purchased. Because there is less risk to the lender, interest rates are typically lower on secured loans. Having a good credit score means lower rates for secured or unsecured loans.
Consumers with bad credit ratings may have a harder time finding an unsecured loan because lenders view these borrowers as high-risk. Lenders may take a chance on a secured loan with a bad-credit borrower because collateral minimizes the risk.
Should You Get a Secured or Unsecured Personal Loan?
If you have little credit history, you may not get to make the choice. Getting a secured credit card gives you the opportunity to build a credit rating that gives you options. If you have bad credit, it will be hard to borrow significant amounts of money except with secured loans.
For everyone else, the answer depends on your individual circumstances, credit rating and what you want to do with the money. With their lower rates and higher borrowing limits, secured loans may be the right choice if you know you’re able to make payments on time. If you don’t, losing your house or car are real possibilities. An unsecured loan doesn’t carry those risks, but the price is higher interest rates.
So, if you’re doing a project where you can qualify for either type of loan, compare the interest rates, fees and repayment rules. If the cost difference is low between secured and unsecured, a personal loan that doesn’t put your property at risk may be right for you. This may be the case if your credit score is high.
In either case, compare rates and fees with several lenders to get the best deal.
Getting Help with Secured Loans
If can’t pay monthly installments on your car or house, don’t wait until you are already in default before acting. If you violate the terms of your loan agreement, lenders can repossess your car without notice. If you fall behind because of a temporary financial problem and you have the money to bring the loan current, contact the lender to reinstate the loan.
If your car is repossessed and you owe more than it is worth, a court could require you pay the difference between the car’s value and what you owe. To avoid this, negotiate with the lender when you can’t make payments. Sell the car yourself if you can net enough to repay the loan.
If you don’t pay your mortgage, the lender will file a notice to foreclose, which could mean you you’re your home – which also may not be worth what you owe. Negotiate with your lenders. You may be allowed to sell your home for less than you owe and the lender may agree not to pursue a deficiency judgment. For more information for distressed homeowners, visit the federal Department of Housing and Urban Development website, www.hud.gov.
Getting Help for Unsecured Debt
Getting out of unsecured loan debt can be complicated. If you owe more than you can pay, contact the debt holder to discuss debt settlement options.
First, try to organize your finances to pay down your credit card balances. Attack the cards with the highest interest rates first. Cut way back on your spending. If that doesn’t work, consider a debt management program through a nonprofit credit counseling agency, which will work with credit card companies to reduce interest rates on your cards and design an affordable monthly payment. This process eliminates the debt over time – usually 3-5 years – and requires discipline and commitment.
The last resort is bankruptcy. It can severely limit the filer’s ability to borrow money in the years ahead, but it may be the only way out. Bankruptcy can’t discharge some debts like student loans and child support, so you must pay them even after your other debts have been removed through bankruptcy.
How to Pay Off Debt
Once you get a loan – whether it’s secured or unsecured – the most important thing is making consistent, monthly payments that put you on track to eliminating that debt. That’s what everyone plans to do, but sometimes life takes unexpected turns, and it becomes hard to do.
Sometimes, the solution may be as simple as creating a budget so you can cut unnecessary spending to free up money to pay down your debts. Consulting a nonprofit credit counseling agency such as InCharge Debt Solutions for help with debt is free, and counselors can help you find ways to get out of debt. One method potential solution is debt consolidation, which is especially effective with credit card debt, which typically carries high interest rates. Consolidation allows you to combine multiple, high-interest debts into a single monthly payment at a lower rate.
Whatever type of loan you get, make sure you stay in control of it.
About The Author
Tom Jackson focuses on writing about debt solutions for consumers struggling to make ends meet. His background includes time as a columnist for newspapers in Washington D.C., Tampa and Sacramento, Calif., where he reported and commented on everything from city and state budgets to the marketing of local businesses and how the business of professional sports impacts a city. Along the way, he has racked up state and national awards for writing, editing and design. Tom’s blogging on the 2016 election won a pair of top honors from the Florida Press Club. A University of Florida alumnus, St. Louis Cardinals fan and eager-if-haphazard golfer, Tom splits time between Tampa and Cashiers, N.C., with his wife of 40 years, college-age son, and Spencer, a yappy Shetland sheepdog.
- Shepard, D., and Huang, P. (2023, February 1) 2023 Credit Card Debt Statistics. Retrieved from https://www.lendingtree.com/credit-cards/credit-card-debt-statistics/
- N.A. (2022, December 8) Credit card debt growing; average household has $8,900. Retrieved from https://journalrecord.com/2022/12/08/credit-card-debt-growing-average-household-has-8900/