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

Loans can come in many different shapes and sizes. They can also be a very large financial commitment. By applying for a loan and receiving the funds, you agree to apply a portion of your income to repay the loan each month. Failure to do so could have a wide variety of consequences, including default, a major hit to your credit score, and even repossession.

While loan amounts and terms can vary widely, there are really only two main types of loans: secured and unsecured.

Let’s start by taking a look at secured loans. A secured loan simply means that it is “secured” against something you own, such as an asset. This means that you must put up an asset as collateral (a house, car, property, etc.), and failure to repay the loan or comply with the terms of the loan could result in repossession of that collateral. The lender would then sell the asset in an attempt to recoup its losses.

There are a few distinct advantages associated with a secured loan. One advantage is that it is usually possible to borrow a larger amount of money with a secured loan, as opposed to an unsecured loan. It is also possible to get more flexible payment terms that can be spread over a longer period of time. Because lenders know they have your collateral waiting in the wings, they are often less concerned about getting their money back and are willing to work a little harder with you. It is for the same reason that interest rates are usually lower as well. Another advantage of a secured loan is that even if you have bad credit, you can still get this type of loan. By providing an asset, you assure your lenders that you mean well and that the full amount of the loan will be repaid. That said, if you already have significant debt, taking on another debt (in this case, the loan) may be a bad idea, pushing you over the edge.

Now let’s take a look at unsecured loans. Unsecured loans do not require you to put up any assets as collateral. The lender establishes a contractual obligation at the time the loan is issued and relies solely on this agreement for repayment. Because there is significantly more risk for the lender, the amount you can borrow is usually much less than a secured loan, and the repayment terms are generally much stricter and spread over a shorter period of time. For the same reasons, the loan criteria are also much stricter. This means that you will be charged a higher interest rate, which will be determined by your income level and previous credit history.

As with secured loans, there are some distinct advantages to unsecured loans. One of those advantages is that they don’t take equity from your home, property, or other assets, so you eliminate repossession risk. Lenders cannot claim any of your belongings, even if you do not pay the loan in full. That being said, they can take legal action against you and turn your account over to collection. Unsecured loans are also cheaper for small purchases than putting the amount on a store account or credit card. Store accounts and credit cards charge very high interest rates, sometimes from the time of purchase, compounded monthly and can add up. If you plan to pay off the loan over the course of a few months, you can save a lot of money by getting an unsecured loan to help pay for your purchase.