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Secured Loan vs Unsecured Loan

Secured Loan vs Unsecured Loan

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Choncé Maddox
Updated September 22, 2022
4 Min Read

If you need money for a large purchase, college tuition, a car, or any other reason, a personal loan can be a great option. Personal loans are easy to apply for and can provide you with the funds you need whether you’re in a financial bind or need to consolidate some of your debt. 

There are two main types of personal loans: secured and unsecured. Which type of loan you choose matters since there are some distinct differences between these options. Continue reading to learn how secured and unsecured loans differ and how to choose the best loan type for your unique situation.

How does a secured loan work?

A secured loan is a loan that’s backed by collateral. This collateral could be a home, car, or other valuable personal property. The most common secured loans are mortgages, car loans and car title loans. 

With a secured loan, you must own the asset you put up as collateral. This means you can use a car for collateral on a loan if you still owe money on the vehicle. Other types of collateral include bank accounts, investments like stocks and mutual funds, as well as valuable collectibles. Secured loans still charge interest and fees like any other loan.

If you are unable to pay back your loan, the lender can claim the collateral you put down as a payment. This is an added risk factor for secured personal loans. With a secured loan, the lender also puts a lien on the asset you use as collateral allowing them to easily seize it if you fail to repay the loan.

Once you do repay the loan, however, the lien is lifted and you’ll have full ownership of your assets again. 

How does an unsecured loan work?

With an unsecured loan, you don’t have to use collateral to secure the loan. Instead, you can qualify based on your credit rating, income, employment status, and other factors. Sometimes, unsecured loans have higher interest rates than secured loans but this isn’t always the case.

Some unsecured loans are installment loans. That means you receive all the funds at once and make payments over time. Other loans are revolving loans, which means you can draw from an existing loan balance whenever you need the money. 

If you apply for an unsecured loan and have a lower credit score, you can expect a higher interest rate especially since the lender doesn’t have any collateral to reduce the risk of offering you a loan.

Even though there is no collateral for a lender to seize, if you fail to repay an unsecured loan, it can damage your credit making it harder for you to borrow money in the future. Your debt can be sent to a collection agency if you continually miss payments and it takes up to 7 years for a negative mark to fall off your credit report.

Should you get a secured or unsecured loan?

Choosing between a secured versus an unsecured loan is not a black and white choice. One of the main determining factors is whether you’re okay with putting up collateral. Depending on the type of personal loan you need, collateral may be required anyway. Still, it’s worth considering that there is more to lose with an unsecured personal loan.

Also, you’ll want to consider your credit and how much you want to borrow. Secured personal loans tend to have higher borrowing limits. However, if you have excellent credit and a steady income, you can still qualify for higher borrowing limits with an unsecured loan.

Finally, consider what you wish to use the loan for. Unsecured loans often have more flexibility in terms of loan use whether it’s for college, paying bills, adoption, funding a wedding or other purposes.

Tips before applying for a loan

Successfully applying for and receiving a personal loan doesn’t have to be difficult, whether you choose a secured or unsecured loan. The key is to plan ahead and carefully assess all your options. Here are a few tips to help when applying for a loan.

Check your credit and assess your financials

Before applying for a loan, it’s important to check your credit and review your report to see where you stand. Your credit score helps determine your interest rate and will be considered for both secured and unsecured personal loans.

See if you can pay off any outstanding debt and address negative marks or discrepancies on your credit report. If you need to dispute something, you can reach out to each of the three major credit bureaus (Experian, Equifax, and TransUnion) separately. 

Also, look at your household budget and assess your current financial situation. How much money can you comfortably afford to borrow? What’s the maximum amount you’re willing to pay each month on your loan? If you’re thinking of going with a secured personal loan, determine what your collateral will be and gather the paperwork to validate your ownership.

Try to get prequalified for a loan online

Banks, credit unions, and online lenders have made it easier to obtain a personal loan these days by allowing you to pre-qualify online. This usually involves filling out a short form on the lender’s website that usually takes no more than five minutes.

Pre-qualifying won’t impact your credit or add a hard inquiry since the lender conducts a soft credit pull. However, this will allow you to take a peek at rates and terms to find out if the loan option is right for you. Plus, if you choose to move forward with the loan, it will be that much easier to finish an application and get your loan funded quickly.

Compare rates and terms

Shopping around for the best loan rates and terms is wise because it ensures you’ll be getting the best deal. Prequalifying online allows you to shop around without submitting an official application and taking on a hard credit inquiry.

Compare loan rates, repayment term lengths, payment options, benefits and perks, and any other feature that is important to you. Also, read the fine print to see what fees the loan comes with such as an origination fee or penalties for paying your loan off early.

Secured or unsecured is up to you

When it comes to comparing a secured loan vs unsecured loan, one is not better than the other. Both secured and unsecured personal loans allow you to get the money you need when you need it. Be sure to assess your needs for a personal loan and the terms you’re looking for. That way, you can compare the two loan options as well as offers from different lenders to see what will work best for your situation.

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