Secured vs. Unsecured Loan: What’s the Difference?

Sure, you could mow your lawn with a weedeater or dig a hole with a spoon. However, you’d be turning an old adage on its head by working harder, instead of smarter. Like tools, loans are much more effective and easier to maintain when you wield the right loan product for the job at hand — whether that’s buying a new car, taking out a mortgage or consolidating high-interest credit card debt. Knowing what an unsecured loan is and how it compares to a secured loan can help you choose the right loan type. Both can help you do things like sand down high interest rates, hammer away at debt or take an ax to large expenses to chop them into manageable monthly payments.

So what is an unsecured loan exactly? What is a secured loan? And what’s the best way to take advantage of them?

In the shortest of terms, the biggest difference between secured and unsecured loans is that secured loans use collateral (like your home or car) to back up the loan. However, there are different reasons you would consider each type of loan. 

Consider this your quick-start guide to the characteristics of secured vs. unsecured loans, as well as a primer on how you can use them to boost your finances.

What is a Secured Loan?

When you think of “secured loans,” think collateral. Collateral provides lenders security against non-payment, or “default.” Instead of having to navigate the legal system to recoup a loan that wasn’t paid in full, the lender can take possession of the collateral a borrower submitted to guarantee the loan.

Having to put up a car, real estate or other valuable assets as collateral for a loan is a sobering thought. But you can’t blame lenders for wanting to ensure an applicant is serious about repaying the loan.

Common types of collateral for secured loans include automobiles, real estate, investments, insurance policies and cash accounts.

Backing a loan with collateral not only affirms your commitment to repayment — it can also raise your chances of approval for that loan, especially if there’s plenty of room for your credit score to improve. With less risk to the lender, it’s often easier to land a secured loan than an unsecured loan, though the latter is still the most common type of personal loan.

Check out some of these common use cases for secured loans: 

• Financing a new car: You don’t need pristine credit to buy a car, because the car itself can serve as collateral.
• Mortgaging a home: Just like financing a car, you can buy a home with a secured loan. 
• Building credit: If you have bad credit or none at all, you can use your own money as collateral to get a small line of credit from a bank. With responsible use, that credit line could grow.
• Emergency money: If you need money and don’t have great credit, you can borrow money by using collateral such as a car title or jewelry.
• Business loans: If you don’t qualify for an unsecured loan, or you need more than offered, you could land a secured loan by backing it with high-value assets, such as real estate or business inventory.

What is an Unsecured Loan?

It’s what it sounds like, yet not exactly so. 

Unsecured loans don’t require the security of collateral. Instead, a potential lender will review your creditworthiness to determine if they’ll extend you an unsecured loan.

While an unsecured loan doesn’t require you to put up collateral like a secured loan, the bank still has recourse to recoup the loan, should you fail to repay it in full. In their toolkits, banks have legal options, such as lawsuits and wage garnishment, which they can use to protect themselves against defaulted loans.

Here are some common use cases for taking out an unsecured loan:

• Debt consolidation: A single lower-interest loan to consolidate all of those high-interest credit cards and other debt.
• Emergency money: A solid emergency fund isn’t always enough, but a significant line of credit can bail you out in an emergency.
• Big-ticket items: Spread out big purchases to fit a large item into your monthly budget.
• Buying a car: You can use a personal line of credit to purchase an automobile from a private seller.
• Home improvement: Homeowners can use a personal loan with a fixed interest rate to make home improvements without using the home as collateral, which is required with other options, like a HELOC (Home Equity Line Of Credit).
• Weddings: Some couples opt for a personal loan to cover large expenses, like weddings.

Your long-term financial goals, monthly income and lifestyle can help you compare both types of loans side-by-side.

Key Differences Between Secured and Unsecured Loans

Now that we’ve covered what exactly goes into each line of financing, it’s important to note that neither is perfect. Whenever you are considering a loan for a large amount of money, it’s important to understand the consequences should the loan become a financial burden for you. 

But there’s good news, too. You can strategically use either to help you make large purchases or consolidate debt. You just need to understand the key differences between a secured versus unsecured loan. 

1. Collateral Requirement
   • Secured loans: They require collateral (most commonly your house, car or another valuable asset). The lender can claim this item if you default on your loan. 
   • Unsecured loans: You don’t have to have collateral to obtain an unsecured loan. The lender, instead, looks at your overall creditworthiness to make their decision to lend you money. 
2. Interest Rates
   • Secured loans: Often, secured loans will have lower interest rates than unsecured loans. 
   • Unsecured loans: Typically, they will have higher interest rates because they are a higher risk to the lender. 
3.  Loan Amount
   • Secured loans: These are better used for larger loan amounts because the lender has collateral. 
   • Unsecured loans: Because they are higher risk, unsecured loans are generally a lower amount. 
4. Approval Process 
   • Secured loans: A more involved approval process, includes an appraisal of the collateral. 
   • Unsecured loans: Typically a much faster approval process. 
5. Risk to Borrower
   • Secured loans: Because you put up collateral, you are at risk of losing your property if you default on your own.
   • Unsecured loans: If you default, the only thing at risk is your credit score, but the damage can be severe.  

Pros and Cons of Secured Loans

If secured loans are looking appealing, take a look at the pros and cons of this particular loan. Always consult a professional for a complete understanding of your loan terms, but we’ll cover the basics here. 

Pros

• Lower interest rates
• The potential to borrow larger amounts
• Easier to qualify for, because they involve less risk to the lender
• Lower credit score requirements

Cons

• Approval could take longer as assets are reviewed
• Have to leverage assets, risking repossession or foreclosure in cases of loan default
• Smaller loans or shorter terms may not be available

In the approval process for a secured loan, lenders also factor in your creditworthiness:  Your debt-to-income ratio, credit scores, the value of your assets, employment status and the health of your accounts. These factors typically weigh more in the application process for unsecured loans.

Pros and Cons of Unsecured Loans

If you’re short on assets or need money quickly, unsecured loans could be great in a pinch. Their flexibility also means you can take out smaller amounts, making large purchases easier if you don’t have all the cash at once. Be warned, however, that higher credit scores are required, and your repayment terms might be more aggressive than a secured loan. Consult a financial expert before you dive into an unsecured loan. 

Pros

• No need to leverage any assets as collateral
• Faster approval process, because there’s no need to evaluate assets
• The potential to take smaller loans

Cons

• Higher interest rates
• Higher credit scores required

How to Choose Between a Secured and Unsecured Loan 

Because it’s a soft credit pull, there’s no impact on your credit score for looking into either a secured loan or an unsecured loan. But once you actually apply, your credit score could take a mild to moderate hit. That hit to your credit scores may come from the hard inquiry to your credit file, as well as the rise in debt that comes from using the loan. In the long run, that hard inquiry will fall off your credit file. And if you keep up with your loan payments, your score could trend upward in a matter of months. 

So, you might find it tempting to jump onto the first pre-approved offer from lenders with names you’ve heard of, especially if the terms are solid, but you could be doing yourself a disservice if you don’t compare offers.

You can compare secured loans, unsecured loans, lines of credit and more to find the best available option for you by using a loan-comparison tool like Fiona. Fiona searches the top online lenders to match you with a personalized loan offer in less than 60 seconds. 

If your credit score is at least 620, its platform can help you borrow up to $250,000, with fixed rates starting at 2.49% and terms from 6 to 144 months.

And don’t worry: Checking to see if you qualify won’t affect your credit score. Plus it’s free, and your information is totally safe — the website uses higher encryption security than many banks. After all is said and done, you could see your money in just a few days.

Just answer a few quick questions here to compare all the best available loan options for you.