Secured vs Unsecured Loan: What’s the Difference?

Secured-Insecured-loan
In this guide, we'll break down the differences between secured and unsecured loans in detail so you know which to request from your chosen lending institution.

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If you need to take out a loan for a home improvement project, for school, for starting a business, or for any other reason, you’ll have to decide between a secured vs unsecured loan.

While both of these loans can be effective and can help you get the cash you need to make your purchases quickly, they also come with distinct advantages and potential downsides. Secured and unsecured loans are also ideal for different types of people or for different uses.

Not sure which to choose? In this guide, we’ll break down the differences between secured and unsecured loans in detail so you know which to request from your chosen lending institution. 

What’s a Secured Loan?

A “secured” loan is any loan that is secured or protected by an asset. In a secured loan arrangement, the lender has legal ownership over one or more items, cash, or other assets ONLY in the event that the borrower defaults on the loan.

For example, imagine that you take out a car loan to purchase a new vehicle. The loan is a secured loan, so it uses the vehicle itself as collateral. In this case, if you were to default on a car loan, the lender could take possession of the car to either sell it or otherwise use it to recoup their costs.

When a secured loan is taken out, the lender holds the title, deed, or overall ownership of the asset used as collateral. The lender maintains ownership of the asset until the loan is paid off in full. Aside from objects or cash, secured loan collateral can include stocks, personal property, and more.

Why Do People Use Secured Loans?

Many lenders offer secured loans for one reason only: security. By retaining ownership of one or more assets, lenders know that they will always get out of the deal with something for their time and money. As opposed to a traditional unsecured loan, in which case a defaulted loan could lead a lender to eat a significant cost, secured loans are safer for lenders no matter what.

Because of this, borrowers can usually find secured loans:

  • With fewer credit score requirements. Thus, many bad credit loans are also types of secured loans
  • For large amounts of money
  • Without very high-interest rates

Indeed, secured loans are among the most common ways in which borrowers can take large amounts of money for business expansions, purchasing expensive items, or paying off other debts. Remember, lenders only provide money to borrowers if they believe they are likely to get repaid with interest.

For this reason, many secured loans also take the form of home equity loans or home equity lines of credit. In these loans, the equity or value of a residence is used as collateral for the broader loan agreement.

Benefits of Secured Loans

Naturally, secured loans have a number of benefits that make them attractive arrangements for many lenders and borrowers who may not have the credit score necessary to be approved for an unsecured loan.

Many secured loans come with lower interest rates, again because lenders are more certain that they will eventually be repaid for their trouble one way or another. Unsecured loans can sometimes be taken out for larger lump sums of cash, like hundreds of thousands or even millions of dollars depending on what assets can be used as collateral.

Lastly, secured loans often come with longer repayment terms. So borrowers have longer to pay back the loan’s entirety before they default on it or run the risk of incurring penalties.

Several of the most common examples of secured loans include mortgages, home equity lines of credit, but loans, auto loans, secured credit cards, and recreational vehicle loans.

What’s an Unsecured Loan? 

In contrast, unsecured loans are the polar opposite of secured loans and do not require collateral for the loan agreement to take place. As their name suggests, unsecured loans are not protected by a security asset. Lenders give money to borrowers without owning any assets or having any legal claim for cash or other things in the event the borrower defaults on the loan.

Because of this, unsecured loans are riskier propositions for lenders, which causes them to offer unsecured loans to different people and under different circumstances. For example, many unsecured loans require higher credit scores, or a pre-existing relationship with the lender, for a borrower to be approved.

Why Do People Use Unsecured Loans?

If secured loans are so safe, why do lenders offer unsecured loans in the first place? In many cases, they believe they can still trust the borrower of an unsecured loan if they have a history with the borrower in question. Many lenders will also judge borrowers based on various aspects of creditworthiness, including:

  • Their financial capacity (i.e. their current debts and their income)
  • Their character, which may include their employment history or credit score
  • The loan’s conditions or circumstances

Unsecured loans are less complex than secured loans because they don’t require lenders to take possession of one or more pieces of property or other assets. So they can also be quicker to commence.

Some examples of unsecured loans include:

  • Credit cards, which are arguably the most common type of unsecured loan
  • Personal for signature loans, which are often used for expensive purchases, school, and other needs
  • Personal lines of credit
  • Student loans
  • Various home improvement loans

Advantages of Unsecured Loans

Just like secured loans have their own advantages, unsecured loans also have several benefits.

For borrowers, the biggest benefit is that they don’t need to worry about one or more of their assets being seized if they default on the loan because of an accident, bankruptcy, or other circumstances. With an unsecured loan, you don’t need to worry that your house or car will be taken from you if you lose all your money due to an expensive and ill-advised business venture.

Lenders also save themselves huge headaches by offering unsecured loans. Even though they may have to eat the cost of an unpaid loan if someone defaults on one of their loans, they don’t have to go to the trouble of actually retrieving or seizing the assets they are legally owed from the borrower through the use of creditors or other organizations.

The Key Difference: Collateral

As you can see, the big difference between secured vs unsecured loans is the presence of collateral which is used as a security for the lender.

Aside from the score difference, secured and unsecured loans can have many of the same attributes or features, including similar terms, interest rates, and more. But secured loans typically:

  • Are for longer terms
  • Have lower interest rates
  • Can be acquired by folks with low credit or bad credit histories

Meanwhile, unsecured loans usually:

  • Have shorter terms
  • Have higher interest rates
  • Are typically only available for folks with fair to excellent credit

Which Type of Loan Should You Choose? 

With this in mind, it’s important to choose which type of loan you take out carefully to avoid exposing yourself to undue financial risk and prevent your assets from being seized.

If you don’t have a very good credit history, you may be better off going with a secured loan. But you need to have a good debt repayment strategy in place and ensure that you have suitable collateral to serve as security for the lender. Naturally, if you don’t have anything to work as collateral, you may not even be approved for a secured loan.

In contrast, if you have good credit, there’s no reason to take out a secured loan unless you can’t find an unsecured loan for the amount that you need for your business venture. Unsecured loans don’t carry the risk of asset seizure with them. Plus, if you already have good credit, you probably already know how to pay back your bills on time.

Summary

Secured and unsecured loans both have their places and can and should be used for different things. Additionally, the availability of secured loans means that, even if you don’t have excellent credit, there’s likely at least one loan out there you can take out to start a new business or to repay existing debts.

If you still aren’t sure whether you should pick a secured or unsecured loan, feel free to contact our financial experts at Seek Capital. Not only can we give you some valuable pointers about where you should look for funding, but we can also connect you to funding sources for personal or business loans depending on your needs.

Sources:

What Is a Secured Loan? | Experian

What is a Home Equity Line of Credit and How Does it Work? | Bank of America

What Is Creditworthiness? | Forbes Advisor

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