Secured or Unsecured Personal Loans: Which is Right for You?

While the two types of loans have many things in common as far as providing the financial support you need, there are also numerous differences between them that distinguish them from each other.

Find out how in this guide!

The Core Difference Between the Two

In its most fundamental form, a secured personal loan needs collateral, whereas an unsecured personal loan does not have any requirement for collateral. This single factor is enough to determine almost all other distinctions that exist between the two types of loans, such as interest rate, likelihood of acceptance, and speed of funding.

For a secured loan, this means pledging some asset as security for your liability, which can include things like your car, savings, home equity, or other similar property. On the other hand, an unsecured loan is based solely on your credit history and other factors related to your financial standing.

There is no one-size-fits-all solution, and the right type of loan will depend on your credit score, the size of your loan, and several other factors.

What Exactly Is a Secured Personal Loan?

The secured personal loan is one where there is a certain piece of property that acts as a guarantee for repayment. In case the loan recipient fails to make timely payments, the lender will seize the asset and sell it to cover losses.

Since lenders see fewer risks with such loans, they are happy to provide them to applicants with poor credit histories or provide more attractive conditions.

"Secured loans are backed by collateral or assets. In case the borrower does not pay, he forfeits his rights to the asset."

Adem Selita, CEO and Co-founder, The Debt Relief Company

Of course, there is always a risk. You don't take out a loan but pledge a property or asset to obtain financing. If the situation gets worse financially, you may end up losing something valuable.

Advantages of Secured Personal Loans

Easier to qualify for:

Since the creditor will have collateral to hold onto, he's taking much lower risks. You'll have more opportunities to get approved even with a not-so-good credit score. For instance, some lenders offer loans with credit scores from as low as 500-580.

Lower interest rates:

One of the benefits of a secured loan over an unsecured one is that you'll pay lower APRs. The lower risk for the creditor means lower interest rates for you.

Higher borrowing limits:

The use of collateral allows for larger loan amounts – up to 80-90% of the value of the collateral in some cases.

Credit-building potential:

Regular on-time repayments are reflected positively on your credit report.

Pro Tip: 

Using a savings account as collateral for getting a loan is the same as borrowing from yourself. Since you won't have to withdraw the funds, the money continues to earn interest on your behalf. This is particularly beneficial if you plan to rebuild your credit with minimal risks.

Drawbacks of Secured Personal Loans

Of course, one drawback of a secured loan is the possibility of losing your collateral. In case you fail to repay the borrowed money on time, the creditor may take possession of your collateral, which can be anything from your car to your savings account.

Secured personal loans can take longer to obtain due to the verification and sometimes assessment of your collateral. In addition, not many financial institutions provide you with this type of loan compared to the alternatives available.

What Is an Unsecured Personal Loan?

An unsecured personal loan requires a favorable credit report on the borrower's side only. No collateral is involved, making it riskier for the lending organization. They consider your credit rating, salary levels, job position, and your DTI ratio when deciding whether or not to lend.

Without any asset to fall back on in case of an unpaid obligation, most lending organizations require a higher credit rating from applicants. The average acceptable score range is 580 to 650, but the most attractive interest rates go to those with scores above 670.

"Unsecured personal loans are not backed by collateral and thus fund quickly but have a higher interest rate."

Randall Yates, Co-founder, VA Loan Network

Nonetheless, this loan type is easily accessible via many lending institutions, including banks, credit unions, and online lenders.

Why Borrowers Prefer Unsecured Loans

Your assets stay protected.

With no pledges, there is nothing to foreclose on. The lenders may sue or blacklist you when you miss repayments, but not take possession of any of your assets.

Faster approval and funding.

The lack of something to appraise makes lenders fast acting. It only takes one business day for some lenders to fund and process applications, while others will do it even faster.

More lender options.

The unsecured loan is the most common loan type offered by lenders. This gives borrowers many options and allows them to shop around and choose the best offer.

The Downsides Worth Knowing

Higher rates are the biggest drawback. The reason being that the risks assumed by lenders are bigger and they compensate for this by raising their prices. Annual interest rates can be anything between 6% and 36%, while for secured loans, they usually stand between 3% and 12%.

The borrowing limit is smaller, and you have to prove that you meet stricter conditions before you borrow. With bad credit scores, the lenders can reject your application altogether or offer very unfavorable terms.

Side-by-Side Comparison

How to Choose the Right Loan for Your Situation

It’s not an all-inclusive list. Here's how to determine whether you should consider each loan type:

Go with a secured personal loan if:

• Your credit score is less than 670, and you need more favorable approval chances

• You desire the lowest interest rate possible and have collateral to offer

• You need to borrow a higher amount

• You're sure that you will be able to repay every payment on time

Go with an unsecured personal loan if:

• You have good to excellent credit (670+), so you'll get competitive rates

• You aren't willing to risk losing some of your property

• You need to get funding fast

• You lack appropriate collateral for the loan

"Secured loans are a great choice for borrowing significant sums of money and having collateral. Unsecured loans are preferable if you need to take out a lower amount of money,"
says Yates.

Pro Tip:

Before choosing one of the two types of loans, use a prequalification calculator. Almost all lenders will let you estimate your approximate interest rate without a hard credit pull that could impact your score. Prequalifying from at least three to five lenders might help save you several hundred bucks.

Steps to Apply for Either Loan Type

Application procedure is simple after making up your mind.

Check your credit score first.

It will be helpful to know how much you qualify for loans, so you can focus on the right lenders and correct any mistakes in advance. Sometimes, several months' worth of improvement will be enough to get a decent score.

Figure out exactly how much you need.

Overborrowing means extra money wasted. You should calculate the needed sum to ensure that you only pay interest on borrowed funds.

Choose your collateral (for secured loans).

Make sure that your lender supports the asset you are willing to put up as collateral. Every lender is different.

Compare multiple lenders.

Pay attention to APR range, terms, fees, and repayments. It will be easy to compare loans using online tools, and it won't affect your credit score.

Submit your application.

Usually, lenders ask for proof of income, employment and financial history. Some lenders allow people to apply online in just minutes.

Review the offer carefully.

You should carefully read the whole loan agreement before signing it. Be on the lookout for hidden costs like origination fees or prepayment penalties.

Receive your funds.

Most likely, you will receive the payment on the same day or next working day after accepting the offer.

Wrapping It Up

In conclusion, which of the two, secured loan or unsecured loan, will work for you will depend on your credit status, intention, and risk tolerance.

If you require low-interest rates, large amounts of money, or can't obtain an unsecured loan because of a bad credit score, then the secured loan is recommended for you. If quick transactions, fewer papers, and no assets involved at all appeal to you, then unsecured loans should meet your expectations.

Do not rush into decision-making without analyzing all offers and their terms and conditions thoroughly. Finally, it is better not to borrow what you don't need.

Frequently Asked Questions

Are secured loans easier to get approved for?

Yes. Secured loans are simpler to get because of collateral, making the risk for the borrower minimal, particularly when it comes to people who have poor credit ratings.

What credit score do I need for an unsecured personal loan?

Most financial institutions tend to start their minimum from 580 up to 650. People who can score above 670 are generally eligible for the best deals.

Can the lender take my collateral if I miss a few payments?

Your property will be repossessed if you fail to pay for an extended period of time, namely, 90 days or more without paying back your installments. A single default means that you would be penalized, but your property won’t be immediately seized. However, multiple late payments increase your chances of being repossessed.

Which loan type has better interest rates?

The interest rate of the loan is much lower than that of an unsecured one (3-12% vs. 6-36%). It also depends on your credit history, income, amount, and lender.