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Loans and financing come in two main flavors: secured and unsecured. For most consumers, deciding between secured and unsecured loans isn’t usually the first thing that comes to mind when choosing a loan. Often consumers don’t even have a choice between choosing a secured or unsecured loan depending on how the loan is already structured.
However, it’s still important to know the differences between these two types of loans. Below is a quick guide to everything you need to know about secured and unsecured loans.
What is a Secured Loan?
Loans that are backed by an asset or collateral are known as secured loans. Common examples of secured loans are mortgages or auto loans. When the borrower agrees to the loan, they are also agreeing that the lender can repossess that asset if the borrower defaults on the loan.
Other less common examples of secured loans are title loans or even pawn loans. With these types of loans, the borrower still promises the lender collateral, in this case the title to one’s vehicle or an item that the borrower leaves with the pawnshop.
Points to Consider:
- Borrowers are usually approved for higher loan limits.
- Secured loans usually have lower interest rates because they are less risky since they are backed by an asset.
- The borrower may not need to have a lengthy or perfect credit history since the loan is backed by an asset.
- Secured loans usually, but not always have longer terms than an unsecured loan. For example, a typical repayment term of a mortgage is often 30 years.
- Specific to a mortgage, borrowers may be able to write off mortgage interest when their primary home is used as collateral.
- If you default on a secured loan, your credit report may be dinged twice. Once for the actual late payments and a second time for the foreclosure or repossession.
- If you default on your secured loan you can also lose your collateral, like your home or vehicle.
- Secured loans often require a lengthy application process with a lot of documentation and paperwork up front.
What is an Unsecured Loan?
In contrast, an unsecured loan is not backed by collateral or an asset. Instead of using an asset to back the loan, the lender looks mainly at the borrower’s creditworthiness as an indicator of their ability to pay back the loan. Common examples of unsecured loans are personal loans, student loans, and the majority of credit cards.
If a borrower defaults on an unsecured loan, creditors can take legal actions against the borrower, put the account in collections, and report the account to credit agencies. However, they cannot typically go after a borrower’s assets.
Points to Consider:
- Applying for an unsecured loan is usually much easier than applying for a secured loan with less paperwork and documentation.
- Borrowers usually receive their funding faster with an unsecured loan. Approval and funding is often received in days instead of months.
- If you have to default on your unsecured loan, you likely won’t have to give up your assets to the lender.
- Unsecured loans can have higher interest rates due to not being backed by an asset.
- Borrowers will need to have good credit and credit history to show lenders that they are worthy credit candidates since these loans are not asset-backed.
- Unsecured loans usually have shorter payback terms.
Which Type of Loan is Right for You?
When you need a loan to finance a new purchase or venture, there isn’t a right or wrong choice between choosing a secured or unsecured loan. However, depending on your needs there could be a loan that will work best for you.
A good way to figure out what type of loan is best for you is to compare and contrast some of the major characteristics between secured and unsecured loans.
How much money do you need to borrow?
When you need to borrower larger sums of money, using a secured loan like a mortgage or auto loan would make more sense. It will be more difficult to find a personal unsecured loan that will loan you the amount of money needed to purchase a home.
How fast do you need your funds?
If you needed your funds yesterday, an unsecured loan might be the right choice for you. Unsecured loans usually have a faster and easier application process and you will receive your funds much quicker than with a secured loan.
Flexibility of repayments
Secured loans usually have a very set repayment schedule. With unsecured loans you are often able to choose between minimum payments and full statement payments. In some instances, you may be able to defer unsecured student loans and retail credit payments until a later date.
How will you use the funds?
Often with secured loans, the money you are borrowing goes directly to pay for the asset that is backing the loan, such as in the case of a home or vehicle. With unsecured loans, you have fewer restrictions on how you spend your borrowed funds.
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This communication is provided for informational purposes only. It is not intended to be an advertisement, a solicitation, or constitute professional advice, including legal, financial, or tax advice, nor is StreetShares providing advice on any particular situation.