Jessica
Written by Jessica
Last updated: Apr.28,2022

If you are looking to borrow money, you should understand the difference between secured and unsecured loans. The main difference is that secured loans require you to put up collateral while unsecured loans do not. There is a time and place for each of these types of loans, so you should understand the pros and cons of each to determine which is right for you. Understanding the difference between types of loans will increase your financial literacy. This is important because utilizing debt can be detrimental if you do not understand the true risks.

Secured loans

Secured loans are tied to an asset such as a car or a house. This means if you default on a secured loan then the lender can seize the asset you provided as collateral. Lenders will likely agree to lend you more money with a secured loan because of the collateral. Interest rates are generally lower with secured loans as well since it is less risky for the lender. 

The only downside to secured loans is that you can' t use them for everything. Secured loans can only be used for specific purposes such as buying a home or a car. Unfortunately, you can' t take out a secured loan to fund your weekend shopping habits. Utilizing a secured loan is beneficial when you are purchasing something that allows you to use one. Otherwise, you will have to settle for an unsecured loan which will come with higher interest rates. 

Examples of secured loans:

  1. 1. Mortgage - A mortgage loan is used to pay for a house. The lender can take your property if you do not pay it off. 
  2. 2. Home equity line of credit (HELOC) - A HELOC is a loan that homeowners can take out against the equity they have in their house. 
  3. 3. Auto loan - An auto loan is when you borrow money to buy a car and make monthly payments to pay it off over time. Most auto loans are secured because your car is used as collateral.

Unsecured loans

An unsecured loan is when you borrow money from a lender without providing any collateral. As a borrower, you do not have to worry about your assets being seized if you do not pay the debt off. This makes it risky for the lender, which is why unsecured loans will come with higher interest rates. Unsecured loans will generally need to be paid off sooner than secured loans as well. 

Your eligibility to receive a loan is based on the five C’s of credit. The five C’s are capacity, capital, collateral, conditions, and character. According to the Navy Federal Credit Union, the five C’s of credit “outline the basic structure of credit analysis - the method used to determine your creditworthiness - and can make a big impact on the loan approval process.” 

Examples of unsecured loans:

  1. 1. Credit card - Credit cards allow you to spend money you don’t have and pay it back with monthly payments plus interest.
  2. 2. Personal loans - Personal loans allow you to receive cash from a bank and pay it back over time with monthly payments plus interest.
  3. 3. Student loans - Student loans are designed for students to pay for their college tuition and other expenses.

What type of loan should you get ?

Determining which loan type is best for you depends on a few different factors. One of these factors may be your credit score. If you have a bad credit score, then it will be more difficult to get an unsecured loan. This is because lenders consider people who have bad credit to be riskier so they may want some form of collateral. In this case, you may be forced to get a secured loan if you are not qualified to get an unsecured loan.

Since secured loans will come with lower interest rates, it is going to be cheaper to use them over unsecured loans. However, unsecured loans do have some benefits including ease of access and flexibility. If you need money quickly it will be much easier to simply put your expenses on a credit card than to apply for a secured loan. Additionally, secured loans can only be used for specific purchases and are less flexible. 

Bottom line

Understanding the differences between secured and unsecured loans will build your financial intelligence and allow you to make more informed decisions. If you are making a purchase that allows you to use a secured loan, it is usually better because you will pay much less in interest. However, make sure you pay it off, or else you risk your assets being seized. Unsecured loans are great for people with less-than-ideal credit or who need money quickly. If you are short on money and need to make a purchase quickly, utilizing an unsecured loan like a personal loan will likely be your best bet.


 

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