If you need to take out a personal loan, one of the first big decisions you’ll need to make is whether to use a secured vs. unsecured loan. There are many differences between the two, all stemming from one fact: A secured loan is backed by some sort of collateral (i.e., an asset that you own) whereas an unsecured loan is not.
What Is a Secured Personal Loan?
A secured loan gets its name because it’s secured by collateral. This collateral can be anything you own that you pledge to the lender. If you default on the loan, the lender gets to take back your collateral.
You’re probably already familiar with secured loans in other areas of your life, such as:
| Loan type | Collateral |
|---|---|
| Mortgages | Your house |
| Home equity line of credit | Your house |
| Auto loan | Your car |
The same idea works for a secured personal loan. If your lender allows it (and not all do), you can pledge collateral, such as a car, a savings account or a certificate of deposit.
Secured personal loans may be preferable if your credit isn’t good enough to qualify for another type of personal loan. In fact, some lenders don’t have minimum credit score requirements to qualify for this type of loan. On the other hand, secured personal loans are riskier for you, because you could lose your asset. If you pledge your vehicle for collateral and the lender repossesses it, you might not be able to get to work.
A secured personal loan may:
- Be easier to qualify for. Secured personal loans are less risky for the lender, who can take possession of your collateral if you default on the loan. In fact, some lenders may require you to use collateral if your credit score or other qualifications aren’t the greatest.
- Be cheaper than other loans. Because secured personal loans are less risky for lenders, they often charge lower interest rates than on other types of loans. Pledging collateral for your personal loan can be one way to reduce the overall cost of your loan. A Texas resident, for example, may be able to win a $10,000, 24-month secured personal loan from Wells Fargo for 7.21%, or more than two percentage points lower than the national average unsecured loan rate.
- Have higher borrowing limits. Lenders might be willing to let you borrow more money if they stand a better chance of getting at least something back if you fail to pay. If you need to borrow a very large amount of money, it might make sense to use a secured personal loan.
- Put your assets at risk. If you think you’ll end up defaulting on a loan, it’s never a good idea to take one out. That’s especially true for secured personal loans, however. If you don’t pay up, your lender can take your collateral.
What Is an Unsecured Personal Loan?
The truth is that most personal loans are unsecured, meaning that there is no collateral involved. If you don’t pay up, the lender stands to lose all of the money they lend to you. For this reason they’re riskier for the lender, which affects other characteristics of the loan.
Unsecured loans also are common in other areas of your life. These types of lending products also are considered unsecured loans because they’re not backed by any collateral:
- Credit cards
- Medical debt
- Student loans
Before you can qualify for an unsecured personal loan, lenders will assess things like your credit score, your payment history listed on your credit report and your income. Most lenders require a credit score of 670 to qualify for an unsecured personal loan.
An unsecured personal loan may:
- Be tougher to qualify for. Since there’s nothing that lenders can immediately take to pay off any unpaid debt, they’re less willing to lend money out for unsecured loans. Unless, that is, you can demonstrate that you’re more likely to pay the loan back.
- Have higher interest rates. Since lenders don’t have any way to recoup their costs if you default on the loan, they often charge higher interest rates. The interest rate on an average 24-month personal loan was 9.5% APR in May 2020, according to the Federal Reserve.
- Have lower borrowing limits. Lenders tend to be more cautious with unsecured vs. secured loans. That’s why you generally can’t get approved for as large amounts if you’re applying for an unsecured loan as compared with secured loans. You can take out a loan of a million dollars or more for a mortgage (secured by your home), but you’d likely never be able to borrow as much using an unsecured loan.
- Not lose your assets if you default—at first. If you default on an unsecured personal loan, there’s nothing that your lender can immediately take. But that doesn’t mean you’re entirely off the hook. Your lender can still report the defaulted loan and ruin your credit. They can also put you into collections and sue you in court. If the judge allows it, they can even garnish your wages. So while you might not lose your bank account at first, eventually you’ll still have to pay up in some way or another.
Key Differences Between Secured and Unsecured Loans
| Secured loans | Unsecured loans |
|---|---|
| Requires collateral | Doesn’t require collateral |
| Easier to qualify for | Harder to qualify for |
| Lower rates | Higher rates |
| Higher borrowing amounts | Lower borrowing amounts |
Where to Get a Personal Loan
Finding a personal loan lender is like finding a tree in a forest: They’re everywhere. You generally can take out a personal loan from one of three different types of lenders.
Banks and Credit Unions
Most banks and credit unions originate personal loans. If you’re looking for a secured loan, these lenders have the advantage because you may be able to use your existing savings account or CDs as collateral. Otherwise, for unsecured loans, it can pay to shop around with multiple banks and credit unions.
It’s also worth noting that credit unions may be easier to get a loan from, especially for people who may not qualify with other lenders. Credit unions are nonprofit organizations that are usually more community-focused than banks, and so they may be more willing to work with you if you’re in a tight spot.
In addition, credit unions often have cheaper rates on personal loans, both secured and unsecured. For example, during June 2020, banks were charging an average interest rate of 10.28%, whereas credit unions were charging a full percentage point less at 9.21%.
Online Lenders
There are many online personal loan lenders. These loans are often quicker to get because you can usually complete the process entirely online. This is nice, but it also means that it may be harder to apply for a secured personal loan if you need it.
There are a few exceptions, but these lenders often still require you to complete some part of the application process in-person. For example, they may need to physically inspect your collateral (such as your car) if that’s what you’ll be using.
Related: Compare Personal Loan Rateshttps://www.credible.com/partners-widgets/personal-loan/rich-cta/?variation=interactive&theme=forbes1&credclid=fa18bf1b-7b9a-4a56-ab90-c84ca3c0ffbc&source=forbes&pageUrl=https%3A%2F%2Fwww.forbes.com%2Fadvisor%2Fpersonal-loans%2Fsecured-vs-unsecured%2F
Alternatives to Personal Loans
Personal loans aren’t your only options if you need to borrow money. Here are some other types of loans you might be able to use, and when they might be best:
- Credit cards. It’s generally not wise to carry a balance on a credit card because they have such high rates. But there are some cases where it can be a good idea, such as if it has a 0% APR offer.
- Medical payment plans. If you need medical care but can’t pay the bill in full, you can often work out a payment plan with the billing department. These are usually very affordable and can even be free. Generous doctors may even waive your balance, but that’s not a guarantee.
- Home equity loans or lines of credit. If you own your own home you can often borrow money against the equity you’ve built up at an affordable rate. But remember: This is a secured loan, so if you default, you could lose your home.
- Low-income grants and loans. If you’re low-income, it’s worth checking with local community organizations to see if there are any grants available for whatever you need. Depending on where you live and what’s available, you may be able to find grants or affordable loans to help you with home repairs, prescription drugs and more.
Read original article here: https://www.forbes.com/advisor/personal-loans/secured-vs-unsecured/