What’s the Difference Between a Secured and Unsecured Loan?

Even if you don’t know it, you probably already have at least a few different forms of unsecured debt. Don’t panic, unsecured debt is normal and often a daily requirement of living. Some typical examples of unsecured debt include credit cards, power bills, phone bills, and even medical bills. Most adults carry a few different types of unsecured debt around in their wallets every single day.

Secured loans, on the other hand, are usually not as common as unsecured debt. There are rarely any pre-approved offers for a secured form of debt. Secured loans are not generally given out to anybody and everybody. They are taken more seriously by lenders with higher risks for the borrower. Some examples of secured debt include mortgages and title loans. Understandably, they are more difficult to get.

What is the Difference Between Secured and Unsecured Loans?

The major difference between a secured and unsecured loan is what is the basic requirements for an application. Many consumers are more likely to be able to apply for and take on unsecured debt, which is typically based on a simple credit score check. Just think about the last time you set up a new utility account, they likely didn’t ask you what assets you owned before approval.

A secured loan, on the other hand, requires collateral in order to qualify for. Collateral is a tangible asset that backs up a loan. For example, a mortgage is backed by the house and property that it is financing which acts as an asset. A title loan may require registration of any vehicles, property, or other significant assets to qualify. If a borrower is unable to pay off the loan, the bank or lender can acquire the assets backing the loan. Secured loans usually come with lower interest rates compared to an unsecured loan because there is less risk to the lender who has collateral to fall back on. 

Defaulting on an unsecured loan could leave the bank or lender without anything to seize. The only way a bank or lender can reclaim unsecured debt in default is by going through a private debt collector or potentially by taking legal action. Understandably, not all unsecured loans are worth going to court over, and therefore unsecured loans are usually sent to a collection agency if they go into default. Because the lender has no collateral, unsecured loans are usually lent out at a higher rate. Greater risk equals higher interest rates.

How Does This Apply to Personal Loans?

Personal loans are typically unsecured. Many banks and online lenders offer personal loans without requiring assets for collateral. Some banks even offer instant or pre-approval based on credit score and income. Since personal loans are usually unsecured, they often come with higher interest rates and harsher penalties for non-payment.

However, while many personal loans are unsecured, there are some banks that only offer personal loans with collateral. Depending on your circumstance, it might be worth it to investigate a secured personal loan. Backing a secured loan with collateral could result in a lower interest rate. Even if you have a perfect credit score, adding in collateral can have a good financial benefit.