Secured vs. Unsecured Loan: What’s the Difference?

When exploring loan options, you’ll encounter two main types: secured and unsecured. A secured loan requires collateral—like a car or house—while an unsecured loan doesn’t. The key difference lies in risk: secured loans offer lower rates but put your assets at risk, while unsecured loans don’t require collateral but may come with higher rates. 

Here’s a breakdown of how these loans work, their pros and cons, and which option might best suit your needs.

What is a secured loan?

Lenders require that you pledge collateral to qualify for secured financing. Collateral is something with value that backs your loan, such as a car, home, or even a savings or investment account. 

Secured loans often have less strict qualifying requirements than unsecured loans, as your lender has the added security of your collateral. For instance, your lender might accept a lower credit score for a secured vs. unsecured personal loan. 

While qualifying requirements might be less strict for secured loans, ensuring you stay on top of your monthly payments is crucial. That’s because your lender can take your collateral, often through repossession or foreclosure, if you default. 

Missing payments can also hurt your credit, making it difficult to qualify for future financing, decent rates, and more. 

Types of secured loans

Car loans, mortgages, and home equity loans are the three most common types of secured loans. That said, other types of secured loans also exist, including:

• Secured personal loans
• Credit-builder loans
• Business loans
• Boat loans
• RV loans
• Motorcycle loans

Collateral requirements are the one thing all secured loans have in common. Apart from that, they may differ in loan amounts, interest rates, repayment terms, borrower requirements, and approval time frame. 

Mortgages, for example, typically have stricter borrower requirements than car loans. That’s because home loans are often very large and repaid over a longer time frame. Thus, they’re more risky for a lender because it’s hard to predict if a borrower can keep up with payments over 15 or 30 years. 

Due to the size of the loan and detailed underwriting process, it also takes longer for a lender to close a mortgage, often 30 to 45 days from loan approval. So you’ll want to account for this if you buy a home. By contrast, you can generally get a car loan from a dealership as soon as the same day of approval. 

How to apply for a secured loan

If you’re interested in a secured loan, here’s a general idea of what to expect from the application process:

1. Find a lender offering a secured loan option
2. Gather your personal and financial information, such as your Social Security number, copies of bank statements, W-2s, and pay stubs
3. Know how much your collateral is worth
4. Apply online, in person, or over the phone
5. Provide your lender with copies of the requested financial and other documentation
6. Await approval
7. Sign final loan paperwork

Pros and cons of secured loans

Here’s a look at the pros and cons of secured loans compared to unsecured loans.

Pros

• Interest rates may be lower

• Less strict borrower requirements

• Repayment terms may be longer

• Could qualify for a higher loan amount

Cons

• Collateral required

• Lender can seize collateral if you default

• Long-term costs could be higher with a longer repayment term

• Less flexibility with how you can use funds

What is an unsecured loan?

Unsecured loans don’t require that you pledge an asset to back your loan. Instead, your lender will look at your credit and financial situation to determine if you qualify. 

Because there’s no collateral associated with an unsecured loan, lenders often have stricter qualifying requirements for borrowers. For instance, you’ll generally need good or excellent credit for approval. Unsecured loans might also have slightly higher interest rates than secured loans. 

Your lender can’t take collateral if you default on an unsecured loan because there’s no collateral backing it. 

But missing payments or paying late will hurt your credit score, which can make it harder to qualify for future financing, get a favorable rate, secure a new apartment or an affordable insurance policy. 

Types of unsecured loans

Personal loans and student loans are the two most common types of unsecured loans. You can use a personal loan to cover almost any cost, except for things like gambling, investing, and illegal activities. Some lenders don’t let you use personal loan funds for higher education, either.  

While personal loans are very flexible, lenders often restrict how you can use a student loan. Typically, private student loans are disbursed directly to your college or university to cover tuition, fees, room and board, and other related costs. You can’t use the funds for just any expense.

Other unsecured financing options include:

• Payday loans (which we don’t recommend due to their very high rates and fees)
• Credit cards
• Peer-to-peer loans

Borrowing limits, loan terms, interest rates, use restrictions, and borrower requirements may differ depending on the type of unsecured loan you want. With a personal loan, for instance, lenders may let you borrow up to $50,000 or even $100,000, but you’ll often get a higher interest rate than you would for a private student loan. 

How to apply for an unsecured loan

The application process for unsecured loans is similar to that for secured loans, though it’s slightly less complicated. That’s because your lender doesn’t need information about your collateral. Here’s a general idea of what to expect:

1. Find a lender offering an unsecured loan option
2. Gather your personal and financial information, such as your Social Security number, copies of bank statements, W-2s, and pay stubs
3. Apply online, in person, or over the phone
4. Provide your lender with copies of requested financial and other documentation
5. Await approval
6. Sign final loan paperwork

Pros and cons of unsecured loans

Here’s a look at the pros and cons of unsecured loans compared to secured loans.

Pros

• No collateral required

• More flexibility with how you can use funds

• Interest costs may be lower with a shorter repayment term

Cons

• Stricter borrower requirements

• Repayment terms may be shorter

• Loan amounts may be lower

Read More

Best Unsecured Personal Loans

Differences between secured and unsecured loans

The major difference between secured and unsecured loans is the collateral requirement. Secured loans require collateral, while unsecured loans don’t. Beyond that, the two types of financing also differ slightly in a few important ways. 

Here’s an at-a-glance look at their differences.

	Secured loans	Unsecured loans
Collateral required	Yes	No
Loan amount	Often higher	Often lower
Repayment term	Often longer	Often shorter
Interest rate	Slightly lower	Slightly higher
Credit score requirements	Lower	Higher
Flexibility of funds	Less flexible	More flexible

Unsecured and secured loans each serve a purpose, and both could be suitable depending on why you’re seeking financing. However, it’s important to understand the differences between these two types of loans before moving forward with an application. 

One of the potential benefits of an unsecured loan is repayment flexibility, which some lenders offer and may not be available for secured loans. In both cases, if the borrower is reasonably confident they can make on-time payments throughout the repayment period and the secured loan offers the lowest interest rate, this option financially makes sense. 

The borrower needs to be aware of the risks associated with secured loans (i.e. repossession of the asset and negative impact on credit score and report) and be comfortable with accepting those risks before making a commitment. 

Erin Kinkade, CFP®

Secured loan vs. unsecured loan: Which is best? 

In general, a secured loan could be better if you’re buying something like a home or car, while an unsecured personal loan could work for another large expense. Here’s when each might be the best option for your situation. 

When a secured loan might be best

• If you have poor credit: If your credit isn’t great, a secured loan could be the better choice. Some secured loans, called credit-builder loans, are designed to help you improve your credit and don’t require good or excellent credit to qualify.
• If you’re using it to buy a specific asset: Mortgages and secured car loans typically have lower rates than unsecured loans, making them a better choice if you’re buying a home or vehicle. 
• If you need a longer repayment term: Certain secured loans may offer longer repayment terms than unsecured loans. Thus, a secured loan with a lengthy term could be a good choice if you need a longer time to repay an expense. 

When an unsecured loan might be best

• If you have excellent credit: The loan rates are reserved for borrowers with the highest credit scores. If you have excellent credit, you could get a competitive rate on an unsecured loan without pledging any collateral. 
• If you have a cosigner: Some lenders let you apply with a cosigner if you have a thin credit file or past credit issues that might prevent you from qualifying for a loan with a decent rate. Cosigners act as support on a loan and are responsible for repayment if the primary borrower defaults. Ideally, your cosigner will have excellent credit, as your lender will consider their credit when determining your rate and loan amount.
• If you need flexibility: Some secured loans are for a specific purpose, such as buying a new car. However, an unsecured personal loan can cover almost any expense, which makes it ideal for borrowers seeking flexibility. 

Generally, if the loan is to purchase an asset (i.e. a vehicle, real estate, boat, etc.) and the asset you purchase is used as the collateral, a secured loan may be the best route. Conversely, if the loan is for a general expense or a financial goal, an unsecured loan may be the better option. 

Erin Kinkade, CFP®