If you’re looking to apply for a loan, it’s important to understand all the options available. Not every type of loan will be right for your situation, so research is key.
Loans are either secured or unsecured. But what does that mean? We’ll explore secured vs unsecured loans, how they work and the benefits they offer so you can make the best decision for your financial situation.
What is a Secured Loan?
To understand the difference between a secured vs. unsecured loan, you need to know how each works. A secured loan is a loan where the borrower must put up collateral. That means a lender will take ownership of the asset offered until the loan is paid off. If you miss a payment or have to default on the loan, the lender can seize the personal property. The most common types of secured loans include:
- Home mortgages
- Home equity lines of credit (HELOC)
- Auto Loans
Types of Collateral
What assets can be put up for a secured loan? Pretty much any valuable personal item. Lenders usually require items that can be easily sold for cash. Also, it must be worth at least the same as the loan amount. Collateral can include:
- Real estate
- Investments including stocks, mutual funds or bonds
- Insurance policies
- Valuables like jewelry, precious metals and high-end collectibles
Benefits of a Secured Loan
A secured loan is mostly used to buy something you can’t purchase outright without financial assistance. For example, most people don’t have the cash available to buy a house or car outright. A secured loan allows you to purchase these big-ticket items. But, like any loan, you need to make sure you can afford the payments.
Here are some overall benefits of secured loans:
- You can borrow larger amounts
- You can build up your credit
- You can secure longer repayment terms
Secured vs. Unsecured Loan Note: While you can borrow a larger amount of money, you still need to pay back what you borrow. Otherwise none of these advantages will benefit you, and you’ll lose whatever asset you put up as collateral for the loan.
What is an Unsecured Loan?
An unsecured loan allows you to borrow money without putting up collateral. Instead, lenders determine your creditworthiness based on things like credit history and income. Lenders will look into your credit history to make sure you’ve successfully paid off loans in the past. They may also look at your income to make sure you have enough to pay off the new loan using a debt-to-income ratio (DTI). DTI is the monthly percentage of your income that goes toward paying debt.
Examples of unsecured loans include:
- Personal loans
- Credit cards
- Student loans
Benefits of an Unsecured Loan
You can use an unsecured loan to purchase just about anything. But some loans, like a student loan, are restricted to things such as college costs or certain investments. Also, because an unsecured loan is based on your credit score, if you have a good score you may be able to qualify for a lower interest rate than you would with a credit score below 670.
Unsecured loans, like a personal loan, can be beneficial if you need to consolidate debt. Personal loans allow you to combine your high-interest debts into one loan, usually at a lower rate.
Other benefits of unsecured loans include:
- You can borrow without putting up collateral.
- The application process is simpler and can be done online.
- You’re able to get money quicker since there’s no need to appraise property.
Secured vs. Unsecured Loan Note: Just because you don’t have to put up collateral, it doesn’t mean there aren’t consequences if you default on your loan. Your credit can take a hit and your debt could be sent to a collector. This can lead to a lawsuit if you don’t pay up.
Which Loan is Best For You?
Now that you understand the difference between secured vs. unsecured loans you can make an informed decision. Whichever loan you decide is right for you, secured vs. unsecured loan, you still need to make sure you understand what you’re signing up for.
Here are 6 questions you should have answers to before you apply for any loan.
- What are the eligibility requirements?
- Is there an application fee?
- Are there penalties for paying off the loan early?
- What is the annual percentage rate (APR)?
- Is there a promotional rate? How long does it last?
- What are all the fees associated with your loan?
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