Borrowing 101: Secured and Unsecured Loans Explained

At least 20 million Americans have loans. 

With the growing expenditure and constant income, taking loans has proved inevitable. Understanding the type of loan you want to take is vital. 

Two common types of loans are secured and unsecured loans. You need to understand what a secured, and unsecured loan entails to establish what’s right for you. The information will guide you when borrowing money. 

If you’re thinking of getting a personal loan and you’re not sure where to start, you are in the right place. 

Keep reading to know more about the differences between secured and unsecured loans. 

What Are the Differences Between Secured and Unsecured Loans?

A secured loan has collateral attached to it. Collateral is anything of value, such as a home or car. The lender has the right to take the collateral if you’re unable to repay the loan as agreed. 

Auto loans and mortgages are the most common types of secured loans. Lenders can sell the collateral such as a car or house to pay the loan with the proceeds. If the asset used as collateral doesn’t cover the loan completely, you have to pay the difference. 

Conversely, the unsecured loan isn’t attached to any collateral. If you fail to pay this loan, a lender can’t claim any of your property for compensation. However, your credit score lowers significantly, making it hard for you to get credit in the future. 

Student loans and personal loans are some of the types of unsecured loans. You only need an exemplary credit history or in some cases, a solid income to get the unsecured loans. You can use your pay stub template as proof of consistent income.   

How to Know the Type of Loan that Suits You

Both secured and unsecured loans are feasible ways of making a new purchase. You can compare the loans to know which suits you best. Here are some comparison points to consider:

Loan Amount 

If you want higher amounts, secured personal loans are the most ideal. Lenders are willing to give you more cash since the risks involved are fewer. However, you’ll have several limitations with unsecured personal loans since there’s no guarantee that the lender will get the money back as per the terms of the loan. 

Fees

Secured and unsecured loans don’t have significant differences in fees. Both loan types require establishment fees and have monthly charges. However, the costs are not standard.  

Lenders have diverse terms. It would be great to shop around and compare the quotes before settling for a lender. Make inquiries as necessary to avoid cases of hidden charges, which might frustrate you in the future.

Interest Rates 

The interest rate for unsecured loans is mostly higher than secured loans. Lenders consider unsecured loans riskier because any form of collateral does not protect them. As such, the riskier a loan is, the more expensive it becomes.  

Personal loans can attract rates between 5.95% and 35.89%, depending on the credit score or the type of loan. Most of the loans with higher rates are unsecured. It is also essential to note that the kind of lender you consider can have higher rates, especially if you opt for traditional lending institutions with high overheads.

Loan Terms 

A secured loan has a longer-term than an unsecured loan. With the unsecured loan, the lending institution seeks ways to minimize the risk; that’s why it requires the borrower to pay the loan as soon as possible. While for unsecured loans, the term is mostly five years or fewer, a secured loan such as a mortgage can go up to 30 years. 

Tax Implications 

A secured loan allows you to write off any interest related to the loan, especially if your home is the collateral. This move is, however, risky as your home is subject to an auction if you fail to repay the loan on time.

If you have an unsecured loan, you can’t write off the interest since there’s no collateral to protect the debt. With this type of loan, your assets are not at risk. 

Using the Loan

Lenders typically require you to state what you intend to do with the fund. A secured loan is characterized by restrictions on how to use the fund. If it’s an auto loan, you have to use the entire amount to cater for the car cost. 

On the other hand, you can use the unsecured loan as you wish. The lender won’t follow up on how you use your credit card. 

Factors to Consider Before Applying for a Loan

Before you can apply for either the secured or unsecured loans, you need to assess if you can afford the repayments. You need to know the repayments and the monthly fees. If your financial position will hinder you from repaying a loan, you might lose valuable assets.

The flexibility of the loan is another great guide. With the amount limits when taking an unsecured loan, you might need to consider a secured loan if you want a higher amount with more extended repayment periods.

It would also help to be clear on whether you want a variable-rate or fixed-rate loan. For instance, an auto loan leans more on fixed-rate loans. Research widely and compare all the available options to get the most competitive deal. 

Ready to Decide?

When you understand the distinction between the secure and the unsecured loans, selecting one becomes more effortless. From the features, a secured loan seems to have better terms than the unsecured loans. With the secured loan, a lender can gauge your ability to pay based on the collateral.

For the unsecured loan, your creditworthiness determines your eligibility. Yet, the secured loan has several limitations, especially on the amount you can get and the high-interest rate. However, you don’t risk losing assets when borrowing an unsecured loan. 

Whether you opt for a secured or unsecured loan, working with a credible lender is crucial. The last thing you want is to lose your home or car out of a malicious lending deal. 

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