Secured vs. Unsecured Loans: What Are the Differences?

There’s a lot to consider when you need to borrow money. Will I qualify? Who has the best interest rate? Am I sure I can afford these payments?

One important factor you may not have given much thought is whether the loan will be secured or unsecured. Understanding the difference between these two types of loans can make a big difference in how much you’re able to borrow—and how much it’ll cost you.

So if you aren’t sure about the differences between secured vs. unsecured loans, read on to find out.

The main difference between a secured loan and an unsecured loan is whether you need to put up collateral. Let’s take a closer look.

Secured loan definition

Secured loans require you to put up an asset as collateral in exchange for funds. In other words, you secure the loan with something valuable. “The lender can repossess the asset if you fail to return the borrowed money,” says Levon L. Galstyan, a Certified Public Accountant with Oak View Law Group. 

For example, an auto loan is secured by the vehicle you’re financing. A mortgage is secured by the property. If you fail to repay the loan, the lender can take back that car or house. That not only motivates you to pay back your debt on time, but it provides a financial safety net for the lender, too. Also, “secured loans tend to have lower interest rates, as there is less risk involved for the lender,” says Galstyan.

Other types of secured loans include some personal loans, home equity loans and lines of credit, life insurance loans, pawn shop loans and secured credit cards. In addition to property and vehicles, other assets that can be used as collateral include bank accounts, investments, precious metals, jewelry, fine art and other valuables.

Unsecured loan definition

On the other hand, unsecured loans don’t require any collateral. Galstyan says you only need to meet the lender’s borrowing criteria, such as having a high credit score. “Lenders usually charge higher interest rates for an unsecured loan because if you can’t repay it, the lender cannot claim any asset as compensation,” he said.

Examples of unsecured loans include some personal loans, student loans, credit cards, peer-to-peer loans and payday loans.

The main benefit of a secured loan is that it can be easier to qualify for, especially if your credit isn’t in the best shape, according to Galstyan: “Secured loans also have higher borrowing limits, so they might be the right type for you if you need to borrow a significant amount.” Plus, he says, the lower interest rates of secured loans also make them less expensive over time than unsecured loans.

On the other hand, secured loans can be riskier for you. “If you don’t pay secured debts, the lender can take the collateral, and you can be charged fees and penalties for the missed payments,” Galstyan said.

In some cases, you don’t get a choice when choosing between a secured or unsecured loan. Auto loans and mortgages, for example, are always secured. But if you have the choice, opting for a secured loan is best when you would otherwise not qualify for the amount and terms you desire.

The main benefit of an unsecured loan is that you don’t have to risk any assets in order to secure financing. The trade-off is that you might have to pay a higher interest rate, or may be approved for a smaller loan amount. 

Still, there are major consequences of defaulting on unsecured debt. You will face late charges, and if it goes unpaid for a long time, the account can be sent to collections, affecting your credit. “You can be repeatedly contacted by collection agencies, and they can file a lawsuit against you if you fail to make payments,” Galstyan said.

Generally, unsecured loans are preferable when you can afford the slightly higher rate. If faced with a choice between an unsecured and a secured loan—such as when shopping around for a personal loan—it’s important to crunch the numbers and see which option makes most sense for you.

Speaking of personal loans, these are a popular source of financing that can be either secured or unsecured. Personal loans allow you to borrow money for almost any reason, and often have lower interest rates than credit cards. Most commonly, personal loans are used to consolidate debt, finance big-ticket purchases and fund home improvement projects.[1]

When shopping for a personal loan, your first instinct may be to check with banks. However, traditional banks are not the only place to find one. You can also get personal loans from credit unions, online lenders and even peer-to-peer lending platforms.

When comparing personal loan offers, it’s important to evaluate a few factors. The interest rate is a big one; rates can vary widely depending on your credit and other factors. Today, the average personal loan interest rate can range between 5% to 36%.

You’ll also want to pay attention to origination fees—these cover the lender’s cost of processing the loan, and can range from 1% to 8% of the loan amount. Some lenders also charge a penalty for paying your loan off early (known as a prepayment penalty), so it’s a good idea to check before committing to a loan.

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