If you have ever shopped around for a car loan or any other line of credit, you may have heard the terms “secured” and “unsecured” loans thrown around. But what are the differences between secured and unsecured loans you may ask?
A secured loan is fully “backed” by a physical asset. This asset can be your home or car that you drive. This asset will act as a form of collateral for your loan. For instance, if you have a secured auto loan and default on the payments, your lender has the legal right to repossess the car and auction it off to recoup their loan expense. These loans tend to have a much lower interest rate since you have a vested interest in repaying your loan balance back.
After a lender seizes your property, it will typically be auctioned off to the highest bidder. The funds from the auction or sale of the property will go towards paying off the balance on the loan you had taken out (whether its a mortgage or auto loan). If the funds from the sale are not enough to cover the loan amount, the lender has the legal right to come after you for the remaining sum of money.
As an example, let’s say you owed $13,500 on your auto loan before you defaulted. If the lender repossesses the vehicle and sells it for only $11,000, the lender can sue you for the remaining balance of $2,500, plus all fees. Typical examples of a secured loan include mortgages and auto loans.
Unsecured loans are just the opposite of secured loans. These loans are not backed by any physical asset. Common forms of unsecured loans include credit cards, student loans, and personal loans. When providing a line of credit with no collateral, the lender is taking a much larger risk than they would with a secured loan. With higher risk also comes a higher interest rate and also shorter repayment terms.
If you were to default on payments for an unsecured loan, the lender does not have the right to seize your property. To get an unsecured loan, you will most likely need to have a healthy credit score and clean credit report. Lenders also look heavily at income and employment history when providing an unsecured loan.
Depending on your situation, getting a secured or unsecured loan may be the right answer. As a review, remember that secured loans provide security to the lender with an asset, the opposite of an unsecured loan with no asset to back it.