While borrowers take out many different types of loans each day, all of them will fall into one of two categories: secured or unsecured loans.
Certain types of loans, like mortgages, are always secured loans. But with other types of debt, you may have the option of choosing between secured and unsecured loan options.
Which type of loan is best? In short, it really depends on your specific situation. In some cases, secured borrowing could be a smart choice, but it could also put you at higher risk. Here's what you need to know.
What is a secured loan?
A secured loan is a type of loan that is guaranteed by collateral that you own. If a borrower defaults on a secured loan, the lender can seize the collateral to minimize its losses. Here are a few common examples of secured loans:
- Mortgages: Secured by your home or property
- Auto loans: Secured by your vehicle
- Secured credit cards: Typically secured by a deposit
- Secured personal loans: Could be secured by a variety of financial assets
- Savings-secured loans: Backed by funds in your savings account or certificate of deposit (CD)
- Pawn shop loans: Secured by personal valuables like electronics, instruments, or jewelry
These are just a few examples of secured lending. But any time you finance the purchase of a physical item, whether it be a couch or a boat, there's a strong chance that you have a secured loan. In each case, the lender has the right to repossess the collateral (if you miss a payment) until the loan has been fully repaid.
What is an unsecured loan?
An unsecured loan is a loan that doesn't require collateral to get. This is different from a secured loan, like a mortgage or a car, where the lender can repossess the asset if you fail to repay the loan.
Examples of unsecured loans include most personal loans, unsecured credit cards, and student loans.
Secured loans vs. unsecured loans
| Unsecured loans | Secured loans | |
| Collateral required? | No | Yes |
| Credit check? | Yes | Yes, but may be able to get one with worse credit history |
| Approval requirements? | Tighter | Looser |
| Speed of application process? | Fast | Sometimes slow |
| Failure to repay? | Lender can't seize your assets | Lender may be able to seize your assets |
Before you borrow money, take out a line of credit, or apply for a credit card, make sure you know the difference between secured and unsecured debts. While either one can help you reach your goals, the presence or absence of collateral is an important consideration that should be decided ahead of time.
Whatever you do, take the time to compare loan options and read the fine print before you sign on the dotted line for any type of loan. If there are any unsavory terms and conditions to be found, they will be tucked away in the fine print.
How do secured loans work
With car loans or mortgages, the item that you purchase is also the collateral. But with personal loans, you receive cash instead of a physical asset. For this reason, most personal loans are unsecured.
However, there are ways for a borrower to secure a personal loan. Here are a few assets that a lender may accept as collateral for a personal loan:
- Home equity
- Savings account or certificate of deposit
- Vehicle title
- Insurance policies
- Stocks, bonds, and other equities
- Jewelry
- Precious metals
- Collectibles
What are the benefits and risks of a secured loan?
Secured loans are less risky for the lender. Because of this, they may be willing to offer you better terms for a secured loan than an unsecured one.
Choosing a secured loan could land you a lower interest rate, a higher borrowing limit, or better repayment terms. And if you are improving your credit score, pledging an asset as collateral could help you receive loan approval.
But while secured loans could provide more borrowing options or more attractive terms, they also represent a higher risk for you as the borrower. If you default on the loan, the bank can take back your home, car, jewelry, or whatever else was used as collateral.
In addition to losing your collateral, your credit score can drop significantly, making it harder to qualify for future loans, credit cards, or even housing. The default could remain on your credit report for up to seven years, and in some cases, the lender might still pursue you for any remaining balance if the collateral doesn't fully cover the debt.
It's also important to point out that not all secured personal loans offer better terms or rates than their unsecured counterparts. In fact, secured loans that are targeted to borrowers with bad credit (like car title loans or pawn shop loans) often charge expensive fees and high interest rates.
Should you pay off unsecured debt with a secured loan?
If you're dealing with crushing credit card debt, you may be tempted to take out a second mortgage or a title loan on your paid-off vehicle to consolidate your debt at a lower interest rate.
On the surface this may seem like a sound financial decision. But, in reality, it's a very dangerous move because you'd be moving an unsecured form of debt over to a secured debt.
While dealing with credit card collection agencies can be overwhelming, they can't take away your personal property without obtaining a court judgment. But once you transition to a secured loan, your collateral is now at risk.
Instead of moving unsecured debt, like credit card bills or medical bills, to a secured loan, try to work out a payment plan with the lender. And if you feel like you need extra help with managing your debt, you may want to set up an appointment with a credit counselor or financial advisor.
Considerations before taking out a secured loan
In some cases, taking out a secured loan could be a smart decision. For example, your bank may offer you a better interest rate and terms on a home equity loan than an unsecured loan. Also, a secured loan could help you rebuild a damaged credit score.
On the other hand, some secured loans aimed at borrowers with low credit scores, like vehicle title loans, can charge outrageous rates and fees. Before you take out a title loan, make sure you've explored all your other borrowing options, like Payday Alternative Loans (PAL), which are offered at credit unions.
As with any loan, you need to make sure that you can truly afford your monthly payments on a secured loan. And be sure to do your research and compare the best personal loan lenders before choosing the right secured loan for you.
Secured loan FAQs
What is a secured loan?
A secured loan is backed by collateral, such as a car, house, or savings account. If the borrower fails to repay, the lender can take the asset to recover the money. Examples of secured loans are mortgages, auto loans, and secured credit cards.
What assets can be used as collateral for a secured loan?
Collateral for secured loans includes real estate properties, vehicles, savings accounts, and valuable personal assets like jewelry or art. The type of collateral accepted varies by lender and loan type.
Is it easier to qualify for a secured loan than an unsecured loan?
Secured loans are often easier to qualify for than unsecured loans. Since secured loans are backed by collateral, they pose less risk to the lender, which can make qualification easier, even for those with less-than-perfect credit.
What happens if I default on a secured loan?
The lender has the right to seize the collateral to recover the outstanding loan amount if you default. The process varies depending on the loan type and the collateral involved, such as foreclosure with mortgages and repossession with auto loans.
Are interest rates on secured loans lower?
Yes, secured loans have lower interest rates compared to unsecured loans because of the lower risk for the lender, thanks to the collateral.
