When facing financial challenges, people often turn to personal loans. But did you know there are two types of personal loans: secured and unsecured? Understanding secured vs. unsecured loans is crucial before borrowing money. The right kind of loan can make all the difference. 

Collateral is what separates secured loans from unsecured loans. Secured loans require collateral, whereas unsecured loans don’t require collateral. Before you borrow money to cover your emergency medical expenses or to buy your dream car, knowing in detail about secured and unsecured personal loans can help you make an informed and wise decision. 

In this blog, we will discuss secured and unsecured personal loans, their key differences, and tips for applying for personal loans.

 

What is a Secured Personal Loan?

A secured loan requires you to keep collateral with the lender. The collateral can be anything from your car to your house. It acts as security for the money you are borrowing. 

Some lenders also accept bank balance and certificates of deposit (CD) as collateral. The lender can keep the collateral if you fail to repay the money. A secured loan has a lower interest rate as collateral given to lenders reduces their risk. 

Types of Secured Loans

Secured loans are a reliable way to access funds to buy a house or a car. Here are the most common types of secured personal loans you can apply for:

• Mortgage Loans: A mortgage loan uses your home as collateral. It’s commonly used to finance the purchase of a house or property.
• Title Loans: Title loans are taken to finance a vehicle purchase. These are secured loans, and the vehicle purchased acts as loan collateral.
• Secured Personal Loans: These loans require considering your savings accounts, investments, or other assets as collateral.
• Home Equity Loans: You can use your home equity as collateral to borrow funds. These loans often cover large expenses, such as debt consolidation and renovation work. 
• Secured Credit Cards: Credit card loans require a cash deposit as collateral, making them ideal for building or rebuilding credit.
• Business Loans: Secured business loans may require assets like equipment, inventory, or property to back the loan.

 

What is an Unsecured Personal Loan?

An unsecured loan is another way to get the requisite funds for financial needs. Unsecured loans provide funds without any collateral, making them a collateral-free option. 

These loans come with high interest rates as no collateral is involved, resulting in high risk for lenders. Creditors check credit history, bank balance, and credit score before loan approval. 

Types of Unsecured Loans

Unsecured loans are an excellent option for people who do not possess any valuable assets for collateral. Here are some common unsecured loans you can apply for:

• Personal Loans: You can apply for unsecured personal loans to cover medical expenses or to pay debts. 
• Student Loans: Student loans are used to cover education expenses, usually tuition fees. They are granted based on your bank balance and credit history. 
• Payday Loans: These are collateral-free short-term loans designed for emergency expenses, typically due on your next payday. 
• Signature Loans: These loans are approved solely based on your signature and creditworthiness. They do not involve collateral. 
• Unsecured Business Loans: These loans are provided to businesses without collateral. The lender considers the business’s financial condition when making the loan. 

 

Key Differences Between Secured and Unsecured Loans

A wise decision can take you out of financial challenges, whereas a bad one can worsen things. Thus, knowing the key differences between secured and unsecured loans is essential before deciding. Here is a breakdown for you:

Feature	Secured Loans	Unsecured Loans
Collateral	Requires collateral like a car, house, or savings account.	No collateral is required; approval is based on creditworthiness.
Interest Rates	Lower interest rates due to reduced risk for lenders.	Higher interest rates as there’s no collateral involved.
Loan Amount	Typically allows borrowing larger amounts.	Generally, it offers smaller loan amounts.
Approval Criteria	Based on collateral value and credit profile.	Based mainly on credit score, income, and financial history.
Risk to Borrower	They can lose the collateral if they are unable to repay the loan.	No asset risk, but missed payments affect credit scores.

 

Which Loan Type Is Right for You?

Choosing between secured loans and unsecured loans depends on your financial situation. If you have a valuable asset, you can apply for secured loans. With low interest rates, secured loans are a great option for large expenses like buying a car or a home. 

On the other hand, if you don’t have collateral, then unsecured loans are the perfect option. They are quick to approve and ideal for small financial needs like medical bills, house rent, etc. Before making a decision, determine the amount you need and compare lenders’ interest rates and repayment terms to make the best decision. 

 

Tips for Applying for Secured and Unsecured Loans

When applying for personal loans, you must prepare all the required documents, as this improves your chances of approval. Here are personal tips for applying for secured and unsecured loans.

For Secured Loans 

• Finalize Loan Amount: Before anything else, determine the amount you need to borrow. Furthermore, you can also decide how much time you need to find it.
• Right Collateral: The first thing to do is choose the right collateral. Lenders prefer valuable assets like cars and homes. 
• Check Asset Value: Before you put your car or home as collateral, check their value in the financial market to get the best deal from the lender. 
• Compare Lenders: Do research before making the final decision. Check out different lenders and compare their interest rates, repayment terms, and payment schedules. 
• Collect Documents: Keep your required documents, such as proof of ownership,  income proof, social security number, etc., handy. This will avoid last-minute hassle. 
• Check Loan Terms: Don’t rush to sign the loan agreement. Double-check everything and try to choose a payment plan that suits your financial situation. Also, ensure the terms mentioned in the agreements are similar to what you agreed upon.

 

For Unsecured Loans

• Determine Amount Required: The first pro tip is to determine the amount you need to cover the expense. Since unsecured loans have high interest rates, borrowing more than you need can worsen your financial situation. 
• Maintain Good Credit Score: Credit score is one of the most important things in unsecured loans. A better credit score increases your chances of loan approval. 
• Compare Lenders: Plenty of lenders offer unsecured loans. To choose the best one for you, compare them based on their interest rates and other factors. 
• Provide Correct Information: When filling out the application for unsecured loans, ensure you provide accurate information about income and employment. Lenders check them during the verification process. 
• Reduce Existing Debts: Before you apply for an unsecured loan, you must clear your existing debts. Clearing debts not only boosts your credit score but also shows lenders that you are financially capable of repaying.

• Consider a Co-Signer: If your credit score is low, adding a co-signer is the best approach. Remember, the co-signer must have a good credit history and should be a close friend or family member. 

 

FAQs

Q1. What Builds Credit Faster, a Secured or Unsecured Loan?

Ans. Both secured and unsecured loans help in building credit rapidly if used responsibly. Timely repayments without default are the key factor in boosting your credit score. However, missed payments on unsecured loans take a harder hit on your credit score than on secured loans.

Q2. What Happens if You Default on an Unsecured Loan?

Ans. Defaulting payment on unsecured loans can damage your credit score, making future borrowing difficult. Furthermore, lenders charge late fees & interest and, in certain cases, can involve collection agencies or pursue legal action. 

Q3. What Credit Score Do You Need for an Unsecured Loan?

Ans. You need a credit score of at least 600-650 to get an unsecured loan. However, the requirement may vary depending on the lender’s policies. A high credit score of 700+ increases your chances of approval and helps you get a lower interest rate. 

Q4. Does a Secured Loan Affect Your Credit Score?

Ans. Yes, secured loans do affect credit scores. Making timely payments shows responsible borrowing and improves your credit score. On the other hand, late or missing repayments can hurt your credit score. You must know that taking a secured loan temporarily lowers your credit score due to hard inquiries by the lender. 

Q5. Can I get a secured loan with bad credit?

Ans. Yes, with a bad credit score, you can get a secured loan. You need collateral to get a secured loan. Having valuable assets like a home or car increases your chances of securing personal loans. Lenders do not pay much attention to credit scores for secured loans. 

 

Q6. Can I convert a secured loan to an unsecured loan?

Ans. Converting a secured loan into an unsecured loan is not a standard practice. However, it is possible to do so if you have a strong credit history. Some lenders might allow you to convert, depending on their policies.