Personal loans are available from banks, credit unions, and online lenders, and can be used for almost any purpose.
There isn't just one type of personal loan, though. Personal loans can be broadly divided into two categories: secured loans and unsecured loans. As you learn the difference between secured vs. unsecured loans, you'll get a sense of which works best for you.
Although secured vs. unsecured loans have some common traits, there are big differences. Some of the key things to know about the differences between secured and unsecured personal loans include:
- Qualifying requirements: Unsecured personal loans are harder to qualify for, and you will usually need excellent credit. Secured loans are easier to get approved for. If your credit score is a problem, secured loans win this round of secured vs. unsecured loans.
- Rules for collateral: Unsecured personal loans don't require collateral; secured personal loans do. If you don't have any collateral to speak of, this round of secured vs. unsecured loans goes to unsecured loans.
- What happens if you don't pay back your debt: If you don't pay back a secured loan, the lender can keep the collateral. If you don't pay back an unsecured loan, the lender has to pursue legal action against you to recover lost funds. This aspect of secured vs. unsecured loans may be a draw.
Let's look a little more closely at some of these key differences between secured vs. unsecured loans so you can better understand which is right for you.
Qualifying requirements of secured vs. unsecured loans
When you apply for an unsecured personal loan, the lender has nothing but your promise to guarantee repayment. This is risky for lenders, because a lender who makes an unsecured loan may have difficulty collecting what you owe if you stop making payments.
Lenders want to control risk, so they will assess how qualified you are as a borrower before giving you an unsecured personal loan. Typically, lenders look at your credit score, your income, and your existing levels of debt before deciding to give you an unsecured loan.
If you don't have a solid credit history, you owe a lot of money, or your income is too low and the lender is concerned about your ability to make payments, you won't get approved for an unsecured loan.
This is where the subject of secured vs. unsecured loans takes a turn. With a secured loan, you put up collateral, which means you must have assets (like jewelry, a savings account, or something else of value) to give the lender in case you can't pay the loan. Since the lender has an ownership interest in this collateral, there are far fewer risks in lending to you. If you don't pay, the lender could keep the assets as reimbursement.
Because the risk to the lender is lower, it's much easier to get approved for a loan that's secured than to get approved for an unsecured loan. Even borrowers with a limited credit history or with poor credit often qualify.
Rules for collateral on secured vs. unsecured loans
With an unsecured loan, you do not need to have any collateral. This means you don't need to put any assets at risk to guarantee the loan. Your property can't directly be taken by the lender in the event you don't pay the loan.
With a secured loan, you do need collateral. In most cases, this means you put some money into a special savings account controlled by the personal loan lender, or you give a lender an ownership interest in a savings or investment account. However, other assets can also be used as collateral, such as a vehicle, your home, or certificates of deposit (CDs). If you don't have assets to use as collateral, you can't qualify for a secured loan.
The amount of collateral required varies depending on the lender's policies. In some cases, you need collateral valued at 100% of the loan amount or close to it. In other circumstances, especially if you have better credit, you can put up some collateral to guarantee the loan, but can borrow more than the collateral is worth.
Typically, when you use investment accounts or a savings account as collateral, letting the value of the account drop below a certain level violates the terms of the loan agreement. This could trigger an immediate obligation to repay your loan if you don't bring the account value up -- your loan terms specify exactly what occurs if this happens.
Consequences of defaulting on secured vs. unsecured loans
If you don't pay an unsecured personal loan, a lender can try to collect in a number of ways. The lender reports your delinquent payments to the credit reporting agencies, which hurts your credit score. The lender is also likely to contact you repeatedly to try to get paid.
Lenders may collect debts themselves or, after a certain amount of time has passed, may opt to sell the debt to a collection agency. The lender or collection agency could sue you, take you to court, and get a judgement against you. If you don't pay the judgement, the lender could get a court order to enforce it by garnishing your wages or putting a lien on your property. All of this takes time for the lender and requires court visits and legal fees -- it's not easy for a lender to take your money or property.
On the other hand, with a secured loan, the lender has an interest in the collateral because of the way the loan is structured. It's much easier to take property you pledged to guarantee the loan. Depending on loan terms and state laws, the lender may be able to take the money in your savings or investment account when you default, without any court action. Check your loan agreement to find the exact process for seizure of your collateral.
Because it's so easy for the lender to take the assets guaranteeing the loan, your property is at much greater risk if you don't pay a secured loan. When you fail to pay a secured loan, the lender can also report the default to the credit reporting agency and ruin your credit, just as lenders can with secured loans.
The difference between secured vs. unsecured loans
There are key differences between secured and unsecured personal loans. If you have bad credit or otherwise have a hard time qualifying for an unsecured personal loan, a secured loan could provide you with the funding you need. But be aware that a lender can more easily take your property on a secured loan than with an unsecured personal loan -- and you have to tie up some of your assets to qualify for a secured loan.
By understanding these key differences of secured vs. unsecured loans, you can decide which type to apply for, and maximize your chances of getting approved for a loan.
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About the Author
Dana has spent the last two decades as a business writer and news reporter, specializing in loans, debt management, investments, and business. She considers herself lucky to love her job and appreciates the opportunity to learn something new every day.
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