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When shopping for a personal loan, you may be able to choose between a secured and an unsecured loan. Before you choose, learn about the many differences between these loans. Here are 6 examples.
Differences between secured and unsecured personal loans
- Secured loans are backed by collateral and unsecured loans are not.
- Interest rates tend to be lower on secured personal loans.
- There are more restrictions on what an unsecured loan can be used for.
- Secured loans often have higher borrowing limits.
- For borrowers with faulty credit, secured personal loans are easier to get.
- Secured personal loans are for borrowers with collateral and the will to risk losing it.
1. Difference: Collateral
The first difference -- and the most fundamental one -- is what stands behind the loan.
A secured loan is backed by collateral -- like your home or car -- that the lender places a lien on in case you don't make your loan payments. Unsecured loans aren't collateralized, which means your creditworthiness is the only thing backing the loan, and your assets are not at risk in case you default.
2. Difference: Interest rate
Because the lender can recover at least some of its losses if you default on a secured loan, interest rates may be lower. For example, Navy Federal Credit Union, the largest credit union in the United States, offers a secured personal loan with an annual percentage rate as much as about 8 percentage points less than its unsecured loan.
"That means a secured loan, if you can qualify for one, is usually a smarter money management decision versus an unsecured loan," says Katie Ross, education and development manager at American Consumer Credit Counseling in Auburndale, Massachusetts.
3. Difference: What the loan is used for
Most unsecured loans come with few restrictions on what you can use the money for. As long as the loan proceeds aren't going toward gambling, buying securities or illegal activities (or, in some cases, college expenses), you're free to spend the money as you please.
But lenders tend to approve secured personal loans for specific purposes, like buying a boat or a recreational vehicle.
"An unsecured loan is always going to be easier for the consumer to use," says Todd Nelson, business development officer for LightStream, the online lending arm of SunTrust Bank in Atlanta.
There are some secured loans that can be used for multiple purposes. For those loans, you may be able to use your own savings as collateral.
For instance, Navy Federal offers loans secured either by the money in your credit union savings or certificate of deposit account. You can borrow up to the amount in the account, and as you pay down the loan, the account funds become available to you again, says Joe Pendergast, the credit union's assistant vice president of consumer lending.
"Any financial adviser you hear today says you should keep 3 to 6 months of savings in your accounts for a rainy day. Having that money there that you're not going to touch for a rainy day could work to your benefit," Pendergast says.
In some cases, you may be able to offer an asset you own as collateral, and then use the secured loan for other purposes. For example, you can take out a loan to consolidate debts and use your car as collateral, says Dave Hogan, executive vice president for decision analytics and marketing for OneMain Holdings, the Evansville, Indiana-based, parent company of nonbank lenders Springleaf Financial and OneMain Financial.
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4. Difference: Loan amount and terms
Borrowers may be able to win approval for higher loan limits with a secured loan versus an unsecured one, Ross says.
TD Bank, for example, says it will lend up to the balance in the customer's deposit accounts for secured loans; unsecured loans max out at $50,000.
Unlike the unsecured loan, though, TD Bank's secured loan has a variable rate, which means the interest rate is subject to change after you take out the loan.
"Most often, we can offer a larger loan amount to the same customer on a secured basis when compared to an unsecured loan, which may better fit the customer's needs," says OneMain's Hogan. "A secured loan may also provide a longer loan term, which gives them lower monthly payments and more time to repay the loan."
5. Difference: Creditworthiness
If you have poor or little credit, you may not be able to get an unsecured loan from most lenders, although some online marketplace lenders specialize in loans to borrowers with weak credit.
"A secured loan is normally easier to get, as there's less risk to the lender," Ross says. "If you have a poor credit history or you're rebuilding credit, for example, lenders will be more likely to consider you for a secured loan versus an unsecured loan."
TD Bank won't issue an unsecured loan to anyone with a credit score below 680. But it lists no minimum credit score for its secured loan.
And Navy Federal won't check your credit if you take out a secured loan, Pendergast says.
6. Choosing an unsecured loan
A secured loan may charge less interest and you may not be subjected to a credit check, but there are times when an unsecured loan makes more sense -- or may be the only option.
If a borrower has no collateral to back the loan, for example, they won't be able to take out a secured loan, Ross says. And an unsecured loan may be the best option for someone who doesn't want to place their assets at risk in case of default.
"Although the borrower is likely to pay higher interest rates, the advantage in choosing an unsecured loan is that they do not have to worry about something valuable being taken away should they not pay off the loan," Ross says. "More often than not it is a good idea to avoid putting assets on the line whenever possible."
Your credit may also play a role.
Lenders like LightStream cater to borrowers with excellent credit, which allows the lender to offer more favorable interest rates and loan terms than some other institutions. There is no interest rate advantage for someone with superb credit to take out a secured loan with LightStream, Nelson says.
"The rates are now as competitive or oftentimes more competitive than the secured product," Nelson says.
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