Secured vs. Unsecured Loans

Last Updated: October 24, 2017 in Loans • 

Secured loans are backed by an asset of some sort, like a home, a car or an antique. The lender takes a lien on real or personal property in exchange for giving you a loan. A lender approves an unsecured loan based only on your creditworthiness and whether you have the income or assets to repay it.

The most important difference between the two types of loans is that if you fail to make your monthly payment, the lender will be able to take your property that you pledged as security for the loan. If you fail to make a payment on your unsecured loan, the lender has no other option but to sue you in court, get a judgement and collect on it.

Having a low credit score definitely puts you at a disadvantage if you need a loan or want to apply for a credit card. It is almost impossible to obtain any kind of credit unless you provide some security for the loan. Fortunately, there are companies that will help you rebuild your credit, establish a new credit score or give you a loan if you need it. Whether you have a secured or unsecured loan, making timely payments of at least the minimum balance will help you rebuild your credit quickly.

Taking out a loan is one of the best ways to improve your credit score. Whether your lender offers a secure or unsecured loan will depend upon your credit score, your income and the amount and type of loan. If you have bad credit, you may still qualify for an unsecured loan through your credit union for example, but you will likely pay a higher interest rate and qualify for a lower amount of credit than you’d like.

Unsecured Loans

Banks and lenders usually reserve unsecured funds for customers with high credit scores. Unsecured credit is offered almost exclusively based on your credit score and your ability to repay based on your income. Unsecured loans do not require that you put up collateral to receive the funds from the bank.

Unsecured loans are based on your past creditworthiness, that you’ve demonstrated you are trustworthy and will make your payments on time. An unsecured credit card is a form of unsecured loan, as are education loans, and other personal lines of credit and small home-improvement loans. Because these are riskier for lenders, you may pay a higher interest rate and receive a lower credit limit.

Secured Loans

Lenders offer secured credit in exchange for taking a lien or interest in real or personal property that you own. While it’s true that people with bad credit can usually only obtain only secured credit, it is often the only type of credit available to anyone who buys a house, car or any other large purchase. Lenders take security in the property you are buying when you buy a car or get a first or second mortgage on a home, even when you have perfect credit. The lender will usually keep the physical title to the car or the house, or keep possession of the personal property you’ve given as collateral until the loan is paid off.

Lenders may also let you use a bank savings account, a certificate of deposit, stocks or bonds as security for a loan. In this case though, you won’t have access to part or all your funds (depending upon the size of the loan) until your loan is paid in full.

Secured loans, because they are just that for the lender—secure—typically offer a lower interest rate with better repayment terms. If you have bad credit, obtaining a secured loan is a way to obtain funds that you need and rebuild your credit.

Secured vs. Unsecured Loans – The Main Differences

Interest Rate

The interest rate will be lower for a secured loan because if you default on the loan, the lender will be able to collect the amount that you owe by foreclosing on your real estate, repossessing your car or keeping and selling the collateral that you provided as security.

This means that you should think carefully about what you provide to a lender as security for the loan, especially if you are in a situation where you strapped for funds.

Intended Use of Funds

The intended use of funds can dictate the type of loan you can get. Unsecured loans are typically less focused on what you use the funds for. Generally, banks offer secured loans for specific purposes like buying a home, car or improving your home.

The loan amount and repayment terms are more favorable for secured loans. You’ll receive a better interest rate and a longer term during which to pay off the loan.

Credit Score

If you have bad credit, it will be easier to get a secured loan rather than an unsecured loan. Plus, a secured loan will also help you rebuild your credit score if you don’t qualify for an unsecured loan. Just make sure that the lender reports your payment history to the three main credit bureaus.

Beware What You Can Lose

While large, secured loans pretty much keep the economy moving forward, they can also be risky if things start getting a little bumpy. If you lose your job unexpectedly, have an accident or incur large medical expenses, you may not be able to make your loan payments.

The most important thing to remember is that if you default on a secured loan—fail to make payments on time—the lender has a legal right to the property you’ve pledged as collateral. Whether it is your house, your car or your family heirloom, the lender must follow the proper legal course of action to be able to take the property back but it can eventually do so. You’ll want to make sure that you understand what you will lose if you cannot meet the payment obligations.

Unsecured loans demonstrate that you are creditworthy. If you already qualify for an unsecured loan, it’s likely that your credit score is very good or excellent already.