This content is created by AP Buyline in accordance with AP’s editorial guidelines and supervised and edited by AP staff. Our evaluations and opinions are not influenced by our advertising relationships, but we may earn commissions from our partners’ links in this content. Learn more about AP Buyline here.
In a nutshell
If you are looking for a loan, you’ll often see loans referred to as “secured” or “unsecured.” These are two different types of lending, each with its own benefits and disadvantages.
- Secured loans are backed by collateral, such as your home or car, which you risk losing if you miss payments and then default on the loan. They typically offer low interest rates and can be easy to qualify for if you have the collateral.
- Unsecured loans, on the other hand, don't require collateral but often come with higher interest rates. They are also more difficult to qualify for: Lenders will look at your credit, income and other financial factors to determine if you’re approved.
What are secured loans?
A secured loan is a type of loan that is guaranteed by an asset you already own. The lender is given the right to take ownership of this asset if you can’t afford to repay the loan. Common types of secured loans include mortgages and auto loans. In both cases, an asset (your house or car) can be seized if you fail to make repayments on the loan.
These loans often have lower interest rates because the lender has a form of security in case you default on the loan.
Pros:
- Larger borrowing amounts: Since secured loans are less risky for lenders, they are more likely to offer higher borrowing limits. This can be especially helpful when you need a large sum of money for a major expense such as buying a house or a car.
- Lower interest rates: Because secured loans are backed by collateral, lenders see them as less risky and offer lower interest rates compared to unsecured loans. This means you will pay less in interest over time, saving you money in the long run.
- Easier approval: Secured loans are generally easier to qualify for since they pose less risk to the lender. This can be beneficial if you have a lower credit score or a limited credit history.
Cons:
- Risk of losing collateral: If you default on the loan, the lender has the right to seize and sell your collateral to recoup their losses. This means you could potentially lose your home, car or other valuable assets. It's important to only take out a secured loan if you are confident in your ability to repay it.
- Longer application process: Secured loans typically require more paperwork and a longer application process compared to unsecured loans. This is because the lender needs to verify the value of the collateral being used to secure the loan.
What are unsecured loans?
Unsecured loans are not secured against any asset. Because of this increased risk to the lender, they often come with higher interest rates and lower borrowing amounts. The lender will also review your credit score, your income and other factors to determine if you qualify for the loan.
Examples of unsecured loans include personal loans and credit cards.
Pros:
- No risk to collateral: Since there is no collateral required, you won’t risk losing any assets if you default on the loan. Your credit score will decrease if you miss payments or stop paying on your loan, but your personal property will remain safe.
- Quick approval process: Unsecured loans typically have a faster approval process than secured loans since there is no need for collateral verification.
- Flexible use of funds: With unsecured loans, you are not limited to using the funds for a specific purpose. This can be beneficial if you need the money for various different expenses.
Cons:
- Higher interest rates: Since unsecured loans are riskier for lenders, they often come with higher interest rates. This means you could end up paying more interest over time compared to a secured loan.
- Limited borrowing amounts: Without collateral as security, lenders may be hesitant to lend large amounts for unsecured loans. This can be challenging if you need a significant sum of money.
- Stricter qualifications: Unsecured loans often have stricter qualifications, making it more difficult for individuals with lower credit scores or a limited credit history to qualify.
How do secured loans and unsecured loans work?
Both secured and unsecured loans work in similar ways. The main difference is that collateral is required when you apply for a secured loan. Both loan types typically have fixed terms and you can lock in your interest rate during that term.
Secured debt may also have a longer repayment term, while the average unsecured personal loan term ranges from two to seven years. Each month you’ll need to make payments that will go toward interest, the principal loan balance and any fees.
Qualifying for secured loans
The qualification process for a secured loan is typically more straightforward than for an unsecured loan. Lenders are primarily concerned with the value and quality of your collateral, as this minimizes their risk.
This doesn't mean that anyone can get a secured loan, though. You still need to demonstrate an ability to repay the loan, typically through your income and credit history. Each lender has different requirements so these qualifications can vary.
Qualifying for unsecured loans
Unsecured loans rely heavily on your creditworthiness, meaning your credit score and history will play a significant role in the approval process and they’ll likely run a credit check. Lenders will also consider your income and existing debt to determine whether you can afford the loan.
Since there's no collateral involved, the lender has no asset to fall back on if you default, hence the higher scrutiny during the approval process.
Related: How to prequalify for a personal loan
How to apply for secured and unsecured loans
Applying for a loan is a multi-step process, but here are some general steps you can expect to follow for both secured and unsecured loans.
- Research and compare: Shop around and compare different lenders to find the best rates and terms. You can use third party sites like Credible to compare lender offers so you can narrow down the best loan option for your needs.
- Gather your documents: Lenders will typically require proof of income, identification and other financial information. It’s best to have this information on hand so you can upload it promptly and the loan approval process doesn’t get delayed.
- Complete an (online) application: When filling out the application form, make sure you are as accurate as possible to avoid delays.
- Wait for a decision: The lender will review your application and credit profile before making a decision. At this time, you may have to answer some questions or submit additional supporting documentation.
- Receive your funds: If you’re approved, the lender will disburse the funds. This may happen via a direct deposit, a check or a transfer to another account, depending on the lender.
Factors to consider when selecting the right loan type
When considering whether you should take out a secured or unsecured loan, it’s essential to evaluate your financial situation and needs. Some factors you may want to consider include:
How much do you need to borrow?
If you need a large sum of money, you can get either a secured or unsecured loan. Unsecured personal loans can be used for a wide range of expenses and usually have borrowing limits up to $40,000 or $50,000. But you may need to borrow more and that’s where a secured loan can come in handy.
What is the purpose of the loan?
If you're using the loan for a specific purpose, such as buying a car or home, a secured loan is a better option. Unsecured loans are best if you need to borrow a smaller amount of money for bills, an emergency or home projects.
What is your credit history?
If you have a low credit score or limited credit history, an unsecured loan may be more challenging to obtain.
Related: How to check your credit score
How quickly do you need the funds?
If you need money urgently, an unsecured loan may have a faster approval process and quicker access to funds compared to a secured loan. However, if you have time to go through the application process, securing your loan with collateral may offer lower interest rates over the long term.
Related: How long does it take to get a personal loan?
Can you afford the monthly payments?
Be sure to consider the interest rates and repayment terms when determining if you can afford a particular loan.
The AP Buyline roundup
Both secured and unsecured loans have advantages and disadvantages. It’s essential to consider your financial situation and needs before deciding which type of loan is right for you. Remember, taking out a loan is a significant financial decision, so always make sure you understand the terms and repayment obligations before signing your loan agreement and receiving the funds.
Frequently asked questions (FAQs)
Which is better: a secured or unsecured loan?
Secured loans can be a good option if you have a valuable asset to use as collateral and want to secure a lower interest rate or higher borrowing limit. However, it's important to remember that if you default on a secured loan, you risk losing the asset you put up as collateral.
Unsecured loans can be a better option if you don't have a valuable asset to use as collateral or don't want to risk losing an asset. They can also be a good choice if you need a smaller amount of money and have a good credit score, as you may be able to qualify for a competitive interest rate.
Can I get a secured loan with bad credit?
It is possible to get a secured loan with bad credit, as the collateral you put up can help offset the risk to the lender. However, you may still face higher interest rates and less favorable terms compared to borrowers with good credit.
Are unsecured loans riskier than secured loans?
From a lender's perspective, unsecured loans are riskier than secured loans because there is no collateral to seize if the borrower defaults on the loan. This is why unsecured loans can come with higher interest rates and lower borrowing limits.
However, from a borrower's perspective, secured loans can be riskier because you risk losing the asset you put up as collateral if you default on the loan. This is why it's important to carefully consider whether you can afford the monthly payments on a secured loan before taking one out.
Is an unsecured loan safe?
Unsecured loans can be safe if you borrow from a reputable lender and have a plan in place to repay the loan on time. However, it's important to be cautious of predatory lenders who may offer unsecured loans with extremely high interest rates or hidden fees.
Before taking out an unsecured loan, be sure to shop around and compare offers from multiple lenders to find the best deal. It's also a good idea to read the fine print carefully and make sure you understand all of the terms and conditions of the loan.
Do unsecured loans hurt your credit?
Like any other type of loan, an unsecured loan can hurt your credit if you fail to make payments on time or default on the loan altogether. Late payments or defaults can stay on your credit report for up to seven years and can significantly lower your credit score.
On the other hand, if you make all of your payments on time and in full, an unsecured loan can actually help improve your credit score over time by demonstrating your ability to responsibly manage debt.
This content is created by AP Buyline in accordance with AP’s editorial guidelines and supervised and edited by AP staff. Our evaluations and opinions are not influenced by our advertising relationships, but we may earn commissions from our partners’ links in this content. Learn more about AP Buyline here.
