Secured vs. unsecured loans

Secured and unsecured loans: What’s the difference?

The main difference between a secured loan and an unsecured loan is one requires security, or collateral, that the lender can take and sell if you don’t repay the loan. The security might be the item purchased (like a car on an auto loan or a home on a mortgage) or something else of value, like a savings account or other personal property. Collateral reduces the lender’s financial risk when lending money.

Unsecured loans are more difficult to qualify for than secured loans because they are riskier for the lender.

For example, if you get a loan to buy a new or used vehicle, the lender will put a lien on the title. If you default on the loan, the lender can legally repossess the car and sell it to recover the money you borrowed.

Conversely, an unsecured loan doesn’t require collateral. Instead, the only guarantee the lender has is your signature on the loan agreement. If you default, the lender may report it to the credit bureaus, start debt collection or bring a lawsuit.

Unsecured loans are riskier for lenders. As a result, they tend to have higher interest rates, lower borrowing limits and shorter repayment times. You are more likely to qualify for an unsecured loan if you have a strong credit history and a stable source of adequate income.

Secured loans

Borrowers typically take out secured loans to purchase high-value items. Mortgages and auto loans are two common types of secured loans. You can get a secured loan from a bank, credit union or online lender.

Other types of secured loans include home equity loans and home equity lines of credit, auto title loans and business equipment loans.

Qualifications

Qualifying for a secured loan is usually easier than qualifying for an unsecured loan. That’s because there is collateral and less risk involved for the lender. Your credit history, income and the asset being used as collateral all may play a role in qualifying for a secured loan. Some lenders also look at your debt-to-income ratio, which is your total monthly debt payments divided by your total monthly gross income.

Rates

Interest rates on secured loans are often lower than on unsecured loans; however, bad-credit secured loans, like auto title loans, pawnshop loans or payday loans have very high rates. Interest rates are set by individual lenders and depend on factors such as your credit score and the length of the loan term.

Secured loans tend to allow higher borrowing limits and a longer time to repay the loan.

Borrowing limits

Borrowing limits on secured loans are generally higher than on unsecured loans. A mortgage, for instance, allows you to borrow hundreds of thousands of dollars to purchase a home, while a car loan can give you up to tens of thousands to purchase a vehicle. Borrowing limits on secured loans are based on the value of the collateral that secures the loan.

Restrictions

Lenders set restrictions on the types of collateral they'll accept for a secured loan. Mortgage lenders require an appraisal of a home, while auto lenders ask for specific details about a vehicle that secures an auto loan. If you are using a bank account as collateral, the lender might require a minimum balance. There may also be restrictions on how you can use secured loan funds.

Unsecured loans

Borrowers use unsecured loans for all sorts of purposes, including consolidating debt, paying bills, moving, remodeling a home, planning a wedding and handling financial emergencies.

Personal loans and student loans are two types of unsecured loans that have no collateral backing them. You can get an unsecured loan from a bank, credit union, online lender or — in the case of federal student loans — the U.S. Department of Education.

On an unsecured loan, if you fail to repay the lender as agreed, it may have a harder time getting its money back. For this reason, unsecured loans are riskier to lenders, more difficult to qualify for and typically have higher annual percentage rates than secured loans.

As with secured loans, many lenders of unsecured loans report to the credit bureaus. If you make payments on time and your lender reports the activity to the credit bureaus, your credit score can benefit. If you make late payments or default on a loan, your credit score will suffer, making it more difficult for you to get approved for loans in the future.

Rates

Expect to see higher interest rates on unsecured loans compared with secured loans. Lenders use information including your credit score, your income, the loan term and the loan amount to set your rate.

Unsecured loans don’t have collateral, but you’re likely to have a higher interest rate.

Qualifications

As a rule, it’s more difficult to qualify for an unsecured loan than a secured loan because the lender is assuming more financial risk. Since there's no property to repossess if you default, the lender may impose more strict qualification requirements.

You’re likely to need a good FICO Score (starting around 670) and a higher monthly income. One exception is with payday loans, a type of short-term unsecured loan that provides quick cash with no credit check — but with an extremely high borrowing cost.

Borrowing limits

Borrowing limits on unsecured loans depend on the lender and your financial profile. For example, applicants with higher incomes and credit scores may be eligible to borrow more money with an unsecured personal loan.

Restrictions

Unsecured loan funds normally have fewer restrictions than secured loan funds. Unsecured personal loans give you the freedom to use cash for basically whatever you want (as long as it’s legal). But lenders are more selective about whom they lend to. Overall, unsecured loans are more restrictive in terms of approvals, how much you can borrow and how long you have to repay the loan.

Bottom line: Should you get a secured or unsecured loan?

Start by asking yourself how you plan to use the loan funds and assessing your financial circumstances. If you’re buying a home or a car, or you want to leverage the equity in your home to borrow money, you’re going to need a secured loan.

If you need a loan to consolidate debt, pay for a move or deal with a financial emergency, an unsecured loan could be the right solution. Just remember that an unsecured loan in most cases requires a good credit score and a stable, sufficient income.

The most important part of getting a loan is shopping around for the best terms from a reputable lender. Research multiple lenders, comparing how much you can borrow, the length of the loan term, the annual percentage rate and fees before you make a decision. If you don't need cash in a lump sum or if you're unsure how much money you need, you could consider alternatives, including taking out a line of credit.