What's the Difference Between a Secured and Unsecured Personal Loan?

Taking out a personal loan can allow you to get funds you can use for just about any purpose. When you get a personal loan, you can have the money deposited into your bank account. You can then use it to do whatever you'd like, whether that's repaying credit card debts that were at a higher interest rate or funding a wedding, trip, or big purchase.

There are different kinds of personal loans, and it's important to know the difference between secured and unsecured loans. Before you borrow, let's take a look at what each term means and how each type of loan works.

A secured loan requires collateral

When you get a secured loan, you must have collateral. Collateral is something that guarantees the loan. For example, you may be able to use your savings account or a certificate of deposit as collateral.

When you have collateral backing up a loan, the lender has an interest in the property. If you stop making your payments, the lender can take the collateral that guarantees the loan; it doesn't have to try to sue you or try to send you to collections in order to get the money. It's much easier for the lender to recover the funds that it has lent you by simply seizing the asset.

With an unsecured loan, on the other hand, there is no collateral. The lender has no guarantees. It only has your word, promising to repay the loan. If you don't pay it back, it can try to collect from you by doing things like suing you, getting a judgment against you, and asking the court to garnish your wages.

But this is much harder and more expensive, time consuming, and complicated compared with just seizing the collateral guaranteeing a secured loan. As a result, unsecured loans present a greater risk to lenders than secured ones do.

A secured loan can be easier to get approved for

Because a secured loan presents so much less risk to the lender, it can be a lot easier to get approved for one.

Not all personal loan lenders offer secured loans, but when a lender does make one available, even borrowers who don't have perfect credit or who don't have a lot of income should be able to qualify for one.

The ease of qualification is a big benefit for people who may not want to take money out of their savings or a CD and who are comfortable using those assets as collateral -- and who otherwise may not be unable to borrow because they have a financial background that lenders view as a red flag.

Getting a secured personal loan can also help you build credit, in addition to being easy to get approved for, since you can show a positive payment history on your credit report. If you're trying to get any kind of loan so you can build your credit score by proving you're responsible with payments but are having a hard time getting approved, a secured loan could be a good solution due to the ease of approval.

Of course, the downside of a secured loan is, you won't be approved for it if you can't meet the collateral requirements. So this kind of loan isn't for everyone.

You should carefully consider the pros and cons of a secured versus unsecured loan in order to decide which is best for you.