Who wouldn’t like to lead a cash-only lifestyle and avoid interest? But in reality, most of us rely on credit to cover life’s significant expenses over time. Hence, a loan may be your only option to purchase a house or a car, start a business or pay for college.
When considering your credit alternatives, you will usually have to choose between a secured and unsecured loan. A secured loan requires offering up something of value as collateral if you can’t repay the loan. In contrast, unsecured loans allow you to borrow the money outright if the lender approves your request.
Overall, both types of loans have ups and downs. So it’s best to understand the strings attached before you apply. Below is the essential information you should be aware of to make the right decision.
Secured Loans Overview
Several types of secured loans are available to eligible customers. Among other things, these loans must get secured with an asset to reassure your creditor. For example, the guarantee might come in the form of a house, vehicle, savings accounts, or valuables.
Here are some of the most common types.
- Mortgage: If you take a mortgage or home equity, the house you buy will serve as collateral. Inability to repay will lead to foreclosure, and you can lose your home.
- Title loans: An auto loan is available for cars, trucks, motorcycles, and boats that make the loan secured. Not repaying the loan means the lender can repossess the vehicle as repayment.
- Secured credit cards: Such credit cards can help borrowers build their credit scores. To do so, you must put in a cash deposit to serve as collateral. If you don’t execute monthly payments, the lender will withdraw money from the cash that makes loans secured.
- 401(k) loans: Here, you borrow from your existing 401(k) to secure the borrowed funds. This option may seem safer than using your house, but you’re dipping into your retirement funds.
Unsecured Loans Overview
Those who prefer unsecured loans have several options to consider. Most importantly, you don’t have to offer collateral for the funds borrowed. Instead, you must demonstrate that you have a stable income and the capacity to repay on time. As a result, many lenders may be wary when approving.
Check the following examples of unsecured cash before applying.
- Personal loans: People refer to these cash products as “payday loans” or “installment loans” since they have a fixed repayment period. Expect to make monthly contributions in equal amounts.
- Consolidation loans: Easily accessible financing can lead to loans accumulation. In this case, you may consider a consolidation loan to repay accrued debt.
- Revolving loans: Customers can borrow and repay revolving loans from income repeatedly. Lines of credit and credit cards are some examples of this type.
- Student loans: Loans for college usually target students with fewer assets and little or no credit history. In addition, student loans typically have favorable terms and must serve specific purposes.
What Is the Difference Between Secured and Unsecured Loans?
Whether you go for a secured or unsecured loan, the outcome will impact your approval chances, rates, fees, and collateral requirements. The most significant difference between secured and unsecured loans is the collateral. With the first one, you allow the lender to seize the property offered as security if you don’t pay the loan back. With unsecured loans, there’s no collateral involved.
Moreover, creditors take on less risk with a secured loan, so interest rates are typically lower. Here, borrowers have more incentive to repay, and in case of failure, lenders have something tangible to fall back on.
Even better for most borrowers, they can have access to more money with secured loans. The reason is that lenders are confident that they will get their funds back from loan repayments or selling the seized property.
Last, unsecured loans come with fewer restrictions on how the money gets spent. Unless the loan proceeds are going toward illegal activities, you can spend the money as you wish. Conversely, lenders tend to approve secured personal loans for specific purposes, like buying a house or a vehicle.
Interest Rates and APRs
Interest loan rates depend on various factors, and the decisive one is the risk the lender undertakes. In the case of a higher-risk loan, the lender will charge more in interest. In contrast, lower-risk loans will involve less interest.
Secured Loan Rates
Secured loans are a safer option for lenders, who reckon that borrowers stick to the agreement more often when collateral is at stake. Hence, you may qualify for a secured personal loan with an APR of under 6%. But, of course, the exact APR will depend on your terms, income, the amount borrowed, and credit history.
Unsecured Loan Rates
As a rule, unsecured personal loans have higher interest rates. Without collateral (a car, for example), creditors may doubt your capacity to service the debt as agreed. The higher threat for the lender translates into a higher rate for you. As of Q1 2021, the Federal Reserve claimed an average APR of 9.46% for a 24-month unsecured personal loan.
Secured vs. Unsecured Loans—defaulting on Your Loan
Borrowing money means you promised to repay the loan in a set period. So if you cannot make on-time payments, the loan might go into default. This can happen after a missed payment or months later, depending on the terms and your state laws. However, the difference when it comes to defaulting secured vs. unsecured loans can be drastic in this matter.
What Will Happen if You Default on an Unsecured Loan?
If you fail to repay your debt, your credit might suffer severely. Though you won’t lose any asset with an unsecured loan, the cascading effects of not paying can worsen your financial situation.
Late payments past the due date will decrease your credit score and remain on your report for seven years. If your account goes into collections or there’s legal action against you, this information becomes part of your credit history. Serious delinquencies are a red flag to potential lenders, who will think twice before extending or allowing new lines of credit.
What Happens if You Can’t Pay Back Your Secured Loan?
If you fail to settle a secured loan, the lender can take possession of your collateral. Also, being a few days late on a mortgage payment may result in late fees.
Defaulting a secured loan can negatively affect your credit history and credit score for up to seven years. In addition, you may lose your home or car with a secured loan and any cash deposit you put up as collateral. Last, if the proceeds from the collateral sale don’t cover the entire debt, you will owe the remaining balance.
Which Loan Is Right for You?
To figure out which loan best suits your needs, pre-qualify for free with us. Rates and terms will vary depending on your needs but might help you snap up lower interest rates and fees. Besides saving money, a well-termed loan will help you pay it off sooner.
If you have a savings account or other property to provide as collateral, consider applying for a secured loan. This way, your interest rate will likely be lower. Conversely, take an unsecured loan if you don’t have an eligible asset or you’re not willing to lose your tangibles.
What Is the Best Type of Personal Loan for Bad Credit?
Some lenders may be unwilling to offer an unsecured loan to people with bad credit. The reason is that creditors perceive bad-credit borrowers as riskier. As for secured loans, credit requirements may be lower since the borrower takes the ultimate risk.
Some online lenders offer bad credit loans to clients, and they don’t always require collateral. Still, if you believe you can make payments on time and want a lower interest rate, collateral may help you along the way.
Both secured and unsecured loans have inherent pros and cons. For example, secured loans typically entail a lower APR, but you also endanger the property put up as collateral. By contrast, you’ll avoid putting up collateral with an unsecured loan but pay higher rates. In any case, defaulting on any online loan will harm your credit score in the long run.
If you’re still unsure what loan makes sense for your situation, contact our expert team. Ask about rates and APRs, as well as borrowing limits and criteria. Getting more information will help you figure out which loan offer to take.