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?
Although secured loans rely on assets, and will often come in one guise, unsecured lending can come in several different forms.
The following information explains the difference between the two types of loans, the requirements to obtain a secured or unsecured loan, and the consequences of non-payment. Loans by their very nature are beneficial, but it’s important to understand the options available to make the right decision.
Secured vs Unsecured Loans
A secured loan is fully “backed” by a physical asset such as a house or car. This asset will act as a form of collateral for your loan. Unsecured loans are not backed by any physical asset. Common forms of unsecured loans include credit cards, student loans, and personal loans.
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.
Remember, secured loans will have an asset behind them that the lender can repossess due to lack of payment. This can be a house or a car.
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.
Secured Loan Requirements
Something of value will need to be secured against the loan. For smaller loans, this could be a
personal vehicle, whereas larger amounts may rely on the equity held in the home. There are even specialized lenders that deal with exotic and rare possessions, such as valuable antiques.
The collateral offers the lender security, which means that those struggling to find a loan due to their credit score could make use of their assets to raise funds.
Repaying a secured loan over time can also contribute towards a healthier credit score, meaning that there could be more borrowing options available in the future.
Although a secured loan can be beneficial for those with an adverse credit history, there will still be a thorough underwriting process. This could mean that in some instances a secured loan won’t be available to all consumers. Although those with a good credit score will find that they are able to find competitive rates, it can still be worthwhile comparing different lenders.
The better the credit score, the more buying power you will have in relation to financial products.
Those who are unsure of their current credit standing should obtain a copy of their credit report. Not only will this allow to become informed about outstanding accounts, but it’s also an ideal opportunity to check for mistakes or errors that could lower your credit score.
Since a secured loan allows an asset to be seized due to non-payment, it’s of the utmost importance that applicants are confident that payments can be made on time.
How Much Can You Borrow With a Secured Loan?
An unsecured loan can present itself in many forms, so the amount offered will depend on how much value there is within an asset. Those using their home as collateral will find that they are given access to more funds than if they had used their vehicle to secure the loan.
Depending on the type of collateral, you may need to seek out a specialized lender. Some lenders may be fluent when it comes to loans associated with equity but are unable to offer loans using a vehicle as collateral.
Even those looking for a specialized lender should take the time to compare what services are
available, as even a slight cheaper interest rate could make all the difference over the long-term.
Collections Process for a Secured Loan
Due to a secured loan being financed with an asset, then the collections process is relatively
straightforward. Should the loan be defaulted on, then the asset used to secure the loan will be sold to repay the debt.
The seriousness of this can depend on how much you borrowed, and what collateral is used.
Although some may not mind losing a vehicle, it’s a different thing altogether if your home is
If you think you may miss a payment on your secured loan, be sure to get in touch with your lender and inform them of your circumstances. Chances are, they can help you by allowing you to repay missed payments at the end of the year.
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 in some cases, a shorter repayment term.
If you were to default on payments for an unsecured loan, the lender does not have the right to seize your property.
Unsecured Loan Requirements
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.
Despite a healthy credit score being required, the interest rate can still depend on what the
condition of your credit file. As such, even as something as simple as a missed payment can have an adverse effect on the interest rate you’re offered.
As before, if there are any uncertainties in relation to a credit score, then it’s important to check your credit file as soon as possible.
How Much Can Be Borrowed with an Unsecured Loan?
Unsecured loans are much like secured loans in that the amounts can vary depending on different factors. However, this can be attributed to a credit score, current lending as well as any other
financial commitments you currently have.
Since there is more risk associated with an unsecured loan, lenders may have their own underwriting process to determine if applicants are “credit-worthy“. Many of these lenders take your credit score and add more or less weight to certain aspects.
For many lenders, more emphasis is placed on payment history rather than new credit or credit mix.
This means that each application is processed on its own merits. Depending on your credit history, the amount you qualify to borrow may be different than another applicant.
Different Types of Unsecured Loans
Secured loans can come in many various forms. The product you use can depend on what you’re looking for in the way of credit and whether you’re hoping to obtain a lump sum payment, or just use a line of credit as and when it’s needed.
Personal loans are the most popular type of unsecured loans. The term “personal loan” derives from the fact that the funds from the loan can be used for any and all purposes.
The interest rates for personal loans are normally low for those with a healthy credit score. However, those who may have had adverse credit issues in the past will find that they will pay more in interest due to the risk involved.
Most personal loans offer a fixed interest rate with fixed payments, meaning that the amount you pay each month will not fluctuate.
Credit cards will only charge interest when the card carries a balance. However, depending on the lender, you could find that there are fees associated with the account. This could mean charges are being applied, regardless of whether you’ve used the account or not.
Credit cards can often come with a higher interest rate than personal loans, but this can vary
depending on your credit score and the underwriting process implemented by the lender. Some credit cards will offer a 0% interest rate for the first year, making them a popular choice for debt consolidation.
The credit limit offered will depend again on the applicant’s credit history. In some instances,
applicants may find that they are given a small limit to start with. Once the borrower established a solid history with the credit card provider, a higher limit may be granted.
Similarly, if the lender feels the current limit is too overwhelming, or payments have been missed, your credit limit may be lowered. In some cases, the card issuer may even cancel your credit account.
As student loans are designed to help those in school, they often come with perks that you don’t see with other lines of credit. For example, some student loans may offer flexible repayment terms, whereas others may offer grace periods or even both.
Defaulting on an Unsecured Loan
Even though a lender cannot seize property or assets with unsecured loans, this doesn’t mean that there aren’t consequences when defaulting on an unsecured loan.
Maintaining a healthy credit score can be difficult, and those that have been working hard to do so could see their work undone should they default on an unsecured loan. One single missed payment could have a large impact on your credit score.
Should you wish to take out future credit, you could be subjected to higher interest. In some instances, applicants may find that they’re unable to obtain credit at all if they missed multiple payments in the past.
Of course, there can be unforeseen circumstances that arise, in which case you should contact your lender as soon as possible to ensure that you’re able to rectify the issue quickly.
Neglecting to deal with the issue could mean your credit report is blemished, making borrowing money in the future much more expensive.
The Collections Process for Secured and Unsecured Loans
If you begin to miss multiple payments on a secured or unsecured loan, you can expect to receive multiple warnings via mail. This correspondence will often start out as friendly reminders but will become more urgent as time goes by.
Your lender has the right to report the missed payments to all 3 major credit bureaus. Depending on how delinquent your account is, your credit score may drop as much as 100 points. This is because payment history is the largest factor in your credit score at 35%.
Should you fail to arrange a payment plan with your lender, then you may be sued for the remaining balance. Not only does this mean court proceedings will occur, but more serious
scenarios could mean you end up facing bankruptcy.
Is a Secured or Unsecured Loan Best for Me?
Both secured and unsecured loans come with their own pros and cons, and there’s no cookie cutter answer in place when it comes to recommending the best loan for someone due to the many factors involved.
Even if someone has made use of a secured loan for the exact same situation doesn’t mean that you should opt for the same line of credit.
Each borrowing decisions needs to be based on your own circumstance while considering your current financial position.
Obtaining Your Credit Report
Should you wish to obtain a credit report to review your credit standing, you can do so once a
year for no charge. These reports are obtained from Experian, Equifax, and TransUnion and can be requested together, or scatted throughout the year.
To obtain a free credit report, consumers will need to visit www.annualcreditreport.com or call 877-322-8228 to apply via telephone. The government requires each of the bureaus to provide you with a copy of your credit report once per year.
If you’ve already obtained a free credit report but want to keep track of your credit score on a
regular basis, then you should contact the credit bureaus below.
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.
If you are looking to get a personal loan, CrediReady can help. Our nationwide network of trusted and verified lenders work with borrowers in all credit situations. Take a moment to fill out our free no-obligation loan inquiry form and get the money you need today!