While some people swear by a cash-only lifestyle, the truth is most of us rely on credit to pay for life's big expenses over time. When you want to buy a big-ticket item like a house or a car, open or grow a business, renovate a kitchen or pay for college, you can apply for a loan at either your local back or online to help you cover the cost.
When considering your credit options, you might have to decide between a secured and unsecured loan. Secured loans require that you offer up something you own of value as collateral in case you can't pay back your loan, whereas unsecured loans allow you borrow the money outright (after the lender considers your financials).
There are pros and cons to both types loans, so before you decide anything it's best to understand the strings attached.
What is a secured loan?
A secured loan is a loan backed by collateral. The most common types of secured loans are mortgages and car loans, and in the case of these loans, the collateral is your home or car. But really, collateral can be any kind of financial asset you own. And if you don't pay back your loan, the bank can seize your collateral as payment. A repossession stays on your credit report for up to seven years.
When you take out a secured loan, the lender puts a lien on the asset you offer up as collateral. Once the loan is paid off, the lender removes the lien, and you own both assets free and clear.
Here are the kinds of assets you can use as collateral for a secured loan, according to Experian:
- Real estate
- Bank accounts (checking accounts, savings accounts, CDs and money market accounts)
- Vehicles (cars, trucks, SUVs, motorcycles, boats, etc.)
- Stocks, mutual funds or bond investments
- Insurance policies, including life insurance
- High-end collectibles and other valuables (precious metals, antiques, etc.)
Secured credit cards, such as the Capital One Platinum Secured Credit Card (see rates and fees) and the Platinum Secured Mastercard® from First Tech Federal Credit Union , are another example of a secured loan. The collateral, in this case, is the cash you put down (often a $200 refundable deposit) that acts as your initial credit limit. You get your deposit back when you close the account.
Because your assets can be seized if you don't pay off your secured loan, they are arguably riskier than unsecured loans. You're still paying interest on the loan based on your creditworthiness, and in some cases fees, when you take out a secured loan.
Don't miss: The best secured credit cards of October 2020
What is an unsecured loan?
An unsecured loan requires no collateral, though you are still charged interest and sometimes fees. Student loans, personal loans and credit cards are all example of unsecured loans.
Since there's no collateral, financial institutions give out unsecured loans based in large part on your credit score and history of repaying past debts. For this reason, unsecured loans may have higher interest rates (but not always) than a secured loan.
Unsecuredpersonal loansaregrowing in popularity. There are roughly 20.2 million personal loan borrowers in the U.S. according to the online lending marketplaceLending Tree. You can take out a personal loan for nearly any purpose, whether that's to renovate your kitchen, pay for a wedding, go on a dream vacation or pay off credit card debt.
Most people get personal loans for debt consolidation, and since personal loans tend to have lower APR than credit cards, borrowers can often save money on interest.
What to know before you take out a loan
Before you take out a personal loan, whether it's secured or unsecured, make sure you have a clear payoff plan.
As a general rule, only borrow what you know you need and can afford to pay back. Make sure you are comfortable with the repayment timeframe. Just because you can get a loan doesn't mean you should, so take your time and do your research before you sign on the dotted line.
Learn more: 10 questions to ask before you take out a personal loan
Information about the Platinum Secured Mastercard® has been collected independently by Select and has not been reviewed or provided by the issuer prior to publication.
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
FAQs
Loans may be secured or unsecured. Secured loans require some sort of collateral, such as a car, a home, or another valuable asset, that the lender can seize if the borrower defaults on the loan. Unsecured loans require no collateral but do require that the borrower be sufficiently creditworthy in the lender's eyes.
What is the difference between secured and unsecured loan? ›
The main difference between secured and unsecured loans is collateral: A secured loan requires collateral, while an unsecured loan does not. Unsecured loans are the more common of the two types of personal loans, but interest rates can be higher since they're backed only by your creditworthiness.
What is the difference between a secured loan and an unsecured loan quizlet? ›
What is the difference between a secured and unsecured loan? Secured loan uses collateral (i.e. car or house) where unsecured does not use collateral (loan made just on promise to pay it back).
Is it a good idea to get a secured loan? ›
If you have little to no credit history, a secured loan could be a way to improve your credit score and start building a strong credit profile — as long as you make timely monthly payments of the minimum amount or more. Just make sure the lender will be reporting your payments to the main consumer credit bureaus.
What is an example of a secured loan? ›
Mortgages, home equity loans and auto loans are all common examples of secured loans. In the case of a mortgage or home equity loan, your house is the collateral that secures the loan. In an auto loan, it's your car.
Which is better secured or unsecured? ›
Unsecured credit cards tend to come with better perks and rewards, lower fees and lower interest rates. Secured credit cards are usually for people with poor credit or no credit history, whereas unsecured credit cards are usually for people with good credit or better.
Is secured better than unsecured? ›
Secured and unsecured credit cards have similarities, but they are different types of credit cards. Secured cards require a deposit, unlike unsecured cards. Compared to secured credit cards, unsecured credit cards may have lower interest rates and fees and higher credit limits.
What are the main advantages of a secured and unsecured loan secured? ›
Some advantages of secured loans include: You may be able to request larger amounts of money because of the reduced risk to the lender. Some lenders offer longer repayment terms and lower interest rates than those offered for unsecured loans. It may be easier to get a secured loan because of the collateral.
Are secured loans easier to get than unsecured? ›
Are secured loans easier to get? Generally speaking, yes. Because you're usually putting your home as a guarantee for payments, the lender will see you as less of a risk, and they'll rely less on your credit history and credit score to make the judgement.
Are unsecured loans riskier than secured loans? ›
An unsecured loan is supported only by the borrower's creditworthiness, rather than by any collateral, such as property or other assets. Unsecured loans are riskier than secured loans for lenders, so they require higher credit scores for approval.
What Credit Score Is Needed for a Secured Personal Loan? Every lender is different. One may require a credit score of 670, while another doesn't set a minimum score requirement. You'll have to check the eligibility requirements of lenders you're considering to see if they require a minimum credit score or not.
Does a secured loan hurt your credit? ›
Your credit will benefit from a secured loan if you make on-time payments. Payment history accounts for 35% of your FICO® Score☉ , making it the most significant single factor that impacts your creditworthiness. Positive payment history will remain on your credit report for 10 years after you pay off the loan.
Is it bad to pay off a secured loan early? ›
Some lenders may charge a prepayment penalty of up to 2% of the loan's outstanding balance if you decide to pay off your loan ahead of schedule. Additionally, paying off your loan early will strip you of some of the credit benefits that come with making on-time monthly payments.
What are the main disadvantages of a secured loan? ›
Disadvantages of Secured Loans
- The personal property named as security on the loan is at risk. If you encounter financial difficulties and cannot repay the loan, the lender could seize the property.
- Typically, the amount borrowed can only be used to purchase a specific asset, like a home or a car.
Once the loan is paid off, the lender removes the lien, and you own both assets free and clear. Here are the kinds of assets you can use as collateral for a secured loan, according to Experian: Real estate. Bank accounts (checking accounts, savings accounts, CDs and money market accounts)
How much can I borrow on a secured loan? ›
The maximum LTV ratio for a secured loan varies from lender-to-lender, but most lenders will not lend you more than 90% of the value of your property. This means that you would need to have at least 10% equity in your property to qualify for a secured loan.
Do unsecured loans hurt your credit score? ›
A personal loan can affect your credit score in a number of ways—both good and bad. Taking out a personal loan isn't bad for your credit score in and of itself. However, it may affect your overall score for the short term and make it more difficult for you to obtain additional credit before that new loan is paid back.
Is an unsecured loan good or bad? ›
Unsecured loans are a great financing option for people who don't want to offer up collateral, which is something of value a lender can repossess to recoup its losses if you default. However, the lender takes on more risk without collateral and typically charges higher interest rates to compensate for the added risk.
What is an example of a secured and unsecured loan? ›
Mortgages and auto loans are types of secured loans. Unsecured loans don't require collateral but may charge a higher interest rate and have tighter credit requirements because of the added risk to the lender. Many personal loans and most credit cards are unsecured.
Why is an unsecured loan good? ›
The good thing about having an unsecured personal loan is that your personal property usually isn't at risk in the event of a default. So you won't have to worry about losing your home or any of your other assets if you get laid off and making on-time payments becomes difficult or impossible.
