Personal loans provide an excellent avenue for individuals to get access to money when they need it. The first and most important decision you’ll need to make when shopping for a loan is secured vs. unsecured personal loans. The choice will depend on your financial goals, financial situation, the amount you want to borrow,and what lenders are willing to offer you.
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Secured personal loans
Secured personal loans are agreements in which the borrower puts up some form of collateral as a guarantee in case they are unable to pay back the borrowed money. In other words, you agree to give something to the lender if you can’t make your payments. Because this guarantee lowers the risk to the lender, borrowers have a better chance of getting approval as well as getting a better interest rate.
The two most common types of secured personal loans are auto loans and home loans. With both of these secured personal loans, the car or house you are purchasing is your collateral. When you get your loan, you agree to pay back the money to the lender. But you also agree that if you are unable to pay back the loan, the lender can take the car or house as payment.
With non-auto or non-home personal loans, you can use other assets like bank accounts, certificates of deposit or even stock in member-owned banks as collateral. For example, Navy Federal lets borrowers secure a personal loan with certificates of deposit or its shares in the bank. Wells Fargo allows customers to use CDs or their savings accounts to qualify for a secured personal loan within hours.
- Possible larger loan amounts available
- Interest rates are typically lower
- May get easier approval because of collateral
- Must risk collateral in case of default
- Your credit is still at risk
Unsecured personal loans
The opposite of secured personal loans is unsecured personal loans. These borrowing tools allow financial institutions to lend you money without requiring collateral. Because these loans are riskier to lenders, the terms and approvals may not be as appealing. You can expect to see smaller loan size maximums, higher interest rates, and potentially stricter borrowing requirements.
Some of the most popular types of unsecured personal loans are personal loans, medical bill loans, debt consolidation loans and home improvement loans — not including home equity loans or lines of credit. Typically, you’re not very limited in how you can use the money from unsecured personal loans.
Just because these loans give you freedom with how you can spend your money does not mean you should use them for frivolous purchases. The general advice with unsecured personal loans is to use them only for necessary expenses like medical bills, debt consolidation and required expenses.
Using these loans for things like vacation, new toys or weddings may seem like a good idea, but it could entice you to purchase something you can’t afford. Just because you don’t have a direct piece of equipment or property on the line, does not mean you can skip out on this loan. Failure to pay can result in destroying your credit and getting sued by the lender for repayment.
- Little restriction on how loans can be used
- Collateral and property is not required to get a loan
- Can be a much faster approval process
- Higher cost of borrowing
- Lower loan amounts
- May have unfavorable repayment terms
Secured vs. unsecured personal loans
Settling the debate of secured vs. unsecured personal loans depends heavily on your situation. First, do you have collateral that makes you eligible for a secured loan? If you don’t, then your only option for the funding will be an unsecured personal loan. Be aware that the item you are purchasing may be used for collateral.
If you do have eligible collateral, you need to decide if you’re willing to leverage that to get your loan. Yes, all of us take out loans with the intent of paying them back. However, life can change. If life turns out of your favor, will you be able to continue without that piece of collateral? If not, you may want to look into an unsecured loan option.
Ideally, secured personal loans will be cheaper and give you access to more money. However, they do have their drawbacks. You have collateral on the line, limitations on where and how you can spend the money, and the approval process can be slower. If these drawbacks are deal breakers, you’ll want to gravitate to unsecured personal loans.
The bottom line
You can’t answer the question, ‘which is better, unsecured or secured personal loans’ with a single answer. The answer depends heavily on your financial situation, your unique borrowing needs, and what lenders are willing to offer to you. The best step forward is to consider your needs clearly and see how these needs are met or unmet through secured or unsecured personal loans. By looking at the short term and long-term impacts, you can decide which option is best for you.