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Secured Personal Loans vs. Unsecured Personal Loans
If you’ve researched borrowing money, you may have wondered about taking out a personal loan. So what is a secured loan? And what about an unsecured one? While debt is debt, it turns out there is a big difference between secured and unsecured loans. It’s important to understand secured vs. unsecured loans and how they can impact the way you borrow money.
What are secured and unsecured personal loans?
There is a difference between secured loans and unsecured loans, and it all has to do with collateral. Collateral is something valuable such as a home or car, but it can also be a financial product, like a savings account or certificate of deposit.
[ More: The Best Savings Accounts of 2020 ]
An unsecured loan is a debt without collateral backing. If you default on your payment, the lender could sue you to collect payment. The lender can’t take away your house, car or seize your checking account if you default. Common examples of unsecured loans are credit cards and personal loans — these are backed by your credit score instead.
Secured personal loans require collateral backing. If you default, the collateral you put on the line can be seized to recuperate losses. Common examples of secured loans are a mortgage or car loan. A secured personal loan could also require a CD or savings account as collateral.
Interest rates: secured vs. unsecured personal loans
Because secured and unsecured loans have a different level of risk associated with them, interest rates vary significantly.
A secured loan is seen as less risk of loss, so typically, the interest rate is lower. In the case of a home mortgage, your home is the collateral. Because the lender can take over ownership of your home if you default on the loan, this makes you less of a risk and you’re rewarded with a lower interest rate.
An unsecured loan is riskier for the lender. As a result, the interest rate is typically higher for this loan. With both the unsecured and secured loans, your credit will be impacted if you default on payment. A lower credit score can result in paying higher interest rates on future personal loans or other types of loans.
[ Read: APR vs. Interest Rates ]
Bad credit unsecured and secured loans
If you have bad credit, it may seem like an uphill climb to obtain a personal loan. The good news is, there are lenders who work with those who are challenged in the credit score department.
[ Related: Best Bad Credit Personal Loans of 2020 ]
What you don’t want to happen when you have bad credit is to assume you have little to no options. You should watch out for lenders who prey on those with bad credit, such as bad credit mortgage lenders or payday lenders.
Bad credit mortgages, also referred to as subprime mortgages, have high interest rates for those looking for a home loan. Not only is the interest rate outrageous, but there are also often penalties attached to the loan. This can include a prepayment penalty for paying the loan off early or a balloon payment penalty, where the balance of the loan is due by a certain date.
Payday lenders, or cash advance companies, loan money based on creditworthiness, but your next paycheck is used to pay for the advance. Although these are unsecured personal loans, they are wrought with high interest rates and ridiculous fees. Online bad credit personal loan providers are also guilty of charging high interest rates and numerous fees.
[ Read: When is an emergency loan a good option? ]
Where can you get a personal loan?
You can obtain a personal loan from several reputable lenders, including:
- Online lenders: The internet has made it possible to borrow money without ever stepping foot in a bank. Online lenders such as Marcus by Goldman Sachs and SoFi offer personal loan options.
- Banks: Traditional banks offer personal loans as well. Start with the bank you already have a relationship with and see what terms and fees they offer for personal loans.
- Credit Unions: Credit unions are another great option for obtaining a personal loan. If you’re unsure if you can work with a credit union, start by researching those in your own county or state. You are likely eligible to join more than one credit union.
[ Read: How to Get a Loan With Bad Credit ]
Pros and cons of secured and unsecured loans
|Pros of Secured Loans||Cons of Secured Loans||Pros of Unsecured Loans||Cons of Unsecured Loans|
|Lower interest rateBetter chance of loan approval||Asset is at risk of seizureCollateral needed||No collateral neededUsed for any expenseCan help consolidate debt||Higher interest ratesShorter repayment terms|
How to choose the right type of loan for you
- Determine the amount of money you need to borrow. While you can use a personal loan for any expense, be careful not to borrow too much. If you can’t make your monthly payments, your credit score will suffer.
- Know your credit score. Your credit score will be used in the application for a personal loan. If you can, allow yourself 60 to 90 days to review your credit file prior to applying for a loan. This will give you time to spot errors and get items corrected if necessary.
- Research the lenders. Understand each lender’s credit requirement, fees, terms and other important details.
- Get pre-qualified. You can get pre-qualified for a loan so you know what the terms will be before you officially apply. This will not affect your credit score.
How to apply for a personal loan
- Narrow down your options. Once you’re pre-approved, you can officially apply for a personal loan. When you do apply, it will result in a hard inquiry, which can impact your credit. Limit the number of applications to avoid a lower credit score.
- Proof of income. Be ready to show proof of your income. Different lenders have different requirements, with some requiring monthly or annual income statements.
- Know your liabilities. Some lenders will want information regarding a past bankruptcy or other debts. Be prepared to discuss liabilities impacting your credit score.
- Review the terms and fees. Each lender not only has its own set of requirements, but the terms and conditions of the personal loans can be vastly different. Review all information such as interest rate, all fees, due dates and late penalties.