Secured vs. Unsecured Loan: What’s the Difference?

If you’re debating whether to take out a secured or unsecured loan, you should know that the main difference between the two is whether there is a collateral requirement. Secured loans require collateral, while unsecured loans don’t.

Here’s a closer look at these two types of debt, how they differ and how to decide which one is right for you.

Pros and cons of secured vs. unsecured loans

How does a secured loan work?

The term “secured loan” refers to any loan that is tied to collateral, or an asset such as a car or a piece of property. Secured loans allow the lender to repossess your asset if you fail to keep up with your loan payments.

As a result, they are generally seen as less risky for the lender, so they often come with more lenient qualifying standards and higher loan amounts than similar loans that don’t have collateral attached.

Uses for a secured loan

Although individual lenders may impose use restrictions on their products, secured loans can be used for just about any purpose.

As a rule of thumb, secured personal loans are generally thought to be better for covering large, one-time expenses — like medical debt or wedding costs — since those funds are distributed to you in a lump sum.

Other secured loan products like secured credit cards or home equity lines of credit (HELOCs) may be a better option if you have ongoing costs — like tuition costs or home improvement expenses — because they allow you to borrow money on an as-needed basis.

Qualifying for a secured loan

For the most part, qualifying for a secured loan is similar to qualifying for an unsecured loan.

Your lender will look at the various metrics that make up your financial profile, including your income, credit score and debt-to-income ratio before approving you for the loan. However, in this case, the lender will also consider the value of the asset you’re using as collateral, which may make it easier for you to be approved.

Secured loan interest rates

Since secured loans have an asset attached to them that the lender can use for repayment if you default on the loan, they generally come with lower annual percentage rates (APRs) than you would find with unsecured loans.

Repaying a secured loan

The repayment terms you receive will depend on the type of secured loan product you choose to use. For example, secured personal loans are typically repaid through a series of fixed payments spread out over a number of years. On the other hand, secured credit cards and HELOCs can have variable payments, which means that your payment amount can change over time.

Where to find secured loans

Banks, credit unions and online lenders all offer secured loans. Each lender may ask for a different form of collateral to secure the loan.

Risks associated with secured loans

The biggest risk associated with taking out a secured loan is the risk of losing your asset. If you stop making payments on your loan, a secured loan gives the lender the right to repossess your asset as a form of repayment.

Beyond that, your credit score will also be impacted. Missing or late payments will be reported to the credit bureaus and can cause your score to drop. It’s also important to note that choosing a secured loan will not soften the effects of a missed payment.

Applying for a secured loan

The process behind applying for a secured loan is almost the same as applying for an unsecured loan. There is just an extra step or two involved.

You’ll generally start by filling out an application that asks for information about you and your finances. You’ll also likely be asked to give the lender permission to do a hard credit pull.

Once the application is submitted, you may be asked to submit supplemental documentation, such as W2s or tax returns. You’ll also have to submit any paperwork that proves you own the asset you’re using to secure the loan.

In some instances, the lender may also ask for an appraisal to verify the value of your asset.

How does an unsecured loan work?

Unlike secured loans, unsecured debt is not secured by an asset. Here, loan approval is based mainly on your creditworthiness and the strength of your overall financial profile.

Interest rates tend to be higher for this type of loan. However, the major benefit is that you won’t risk losing your asset if you’re unable to keep up with your payments.

Uses for an unsecured loan

Once again, individual lenders may impose use restrictions on their loans, and different types of secured financing may be better suited for different purposes.

For example, unsecured personal loans are typically thought to be better suited for fixed expenses, while credit cards are generally meant to finance variable or ongoing costs.

Qualifying for an unsecured loan

Qualifying for an unsecured loan often requires less paperwork than qualifying for secured debt. In this case, acceptance is largely based on the strength of your credit history.

That said, it should be noted that bad credit loans do exist. You might just end up paying more for the privilege of borrowing.

Unsecured loan interest rates

Since unsecured loans are not tied to an asset that can be repossessed if you default on the loan, they tend to have higher interest rates. In this case, the interest rate that you’re given will depend heavily on your credit score, with the best rates generally going to the borrowers with the highest scores.

Repaying an unsecured loan

Just like for secured loans, repayment depends on the type of unsecured loan that you’ve chosen to use. Unsecured personal loans are repaid through a series of regular installment payments that are spread out over several months or years. Meanwhile, credit card payments are typically more flexible, allowing you to pay down your loan as much as you’d like, as long as you meet or exceed the minimum payment amount.

Where to find unsecured loans

Banks, credit unions and online lenders also all offer unsecured loans. It is typically easier to find a lender for one of these loans because more lenders offer them.

Risks associated with unsecured loans

Some borrowers may find unsecured loans to be a safer bet because they’re not at risk of losing an asset if they fail to repay the loan. Here, the biggest risk is usually the impact of missed payments on your credit score. Although, it is possible for a collection agency to take you to court if you default on the loan and the debt enters collections.

Applying for an unsecured loan

Applying for an unsecured loan is fairly easy. You usually just need to fill out an application with information about you, your finances and your desired loan amount. You may also be asked to provide supplemental documentation, such as tax forms or pay stubs, as part of the application process.

Should you get an unsecured or secured loan?

Ultimately, whether an unsecured versus secured loan is better for you is a personal financial decision.

If you don’t have assets you can provide as collateral, secured loans may be your only option. However, they can also be a good choice if you have an excellent credit score or are afraid to put an asset that you own at risk.

If you’re confident that you can keep up with the payments, choosing a secured loan can be a savvy way to secure a higher loan amount or more affordable interest rate. But, if the payments may be a struggle for you, think twice before putting an asset on the line. For instance, you could put yourself at risk of losing income if you secure a loan with a car that you use to get to work and it ends up getting repossessed when you fall behind on payments.

Those looking for alternatives to secured loans should know that applying with a cosigner and focusing on bad credit loans are two alternative ways to boost your odds of being approved without having to use an asset as collateral.