Secured and unsecured personal loans work for similar purposes. Find out the key variations between each of these loan types.
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Personal loans are available from banks, credit unions, and online lenders and can be used for almost any purpose you want. There isn’t just one type of personal loan though. In fact, personal loans can be broadly divided into two different categories: secured personal loans and unsecured personal loans.
Although secured and unsecured loans have some common traits, there are big differences between them -- and it’s important to understand those differences so you can decide what type of loan is right for you. Some of the key things you need to know about the differences between secured and unsecured personal loans include:
- Qualifying requirements: Unsecured personal loans are harder to qualify for and you will usually need better credit. Secured loans are easier to get approved for.
- Rules for collateral: Unsecured personal loans don’t require collateral; secured personal loans do.
- What happens if you don’t pay back your debt: If you don’t pay back a secured loan, the lender can keep the collateral. If you don’t pay back an unsecured loan, the lender will have to pursue legal action against you to try to recover lost funds.
Let’s look a little more closely at some of these key differences between secured and unsecured personal loans so you can better understand which is right for you.
Qualifying requirements of secured vs. unsecured personal loans
When you apply for an unsecured personal loan, the lender has nothing but your promise to guarantee repayment. This is risky for lenders because a lender that makes an unsecured loan may have difficulty collecting the money you owe if you stop making payments.
Lenders want to control risk, so they will assess how qualified you are as a borrower before giving you an unsecured personal loan. Typically, lenders look at your credit score, your income, and your existing levels of debt before deciding to give you an unsecured loan.
If you don’t have a solid credit history, you owe a ton of money, or your income is too low and the lender is concerned about your ability to make payments, you aren’t going to get approved for an unsecured loan.
With a secured loan, on the other hand, you have to put up collateral, which means you must have assets you give the lender an ownership interest in to guarantee the loan. Since the lender has an ownership interest in this collateral, there are far fewer risks of lending to you. If you don’t pay, the lender could simply keep the assets as reimbursement.
Because the risk to the lender is lower, it’s much easier to get approved for a secured loan than to get approved for an unsecured loan. Even borrowers with a limited credit history or with poor credit can often qualify.
Rules for collateral on secured personal loans vs. unsecured personal loans
With an unsecured loan, you do not need to have any collateral. This means you don’t need to put any assets at risk to guarantee the loan. Your property can’t directly be taken by the lender in the event you don’t pay the loan.
With a secured loan, you do need collateral. In most cases, this means you put some money into a special savings account controlled by the personal loan lender or give a lender an ownership interest in a savings or investment account you have. However, other assets could also be used as collateral such as a vehicle, your home, or certificates of deposit (CDs). If you don’t have assets to use as collateral, you can’t qualify for a secured loan.
The amount of collateral required will vary depending on the lender’s policies. In some cases, you need to have collateral valued at 100% of the loan amount or close to it. In other circumstances, especially if you have better credit, you can put up some collateral to guarantee the loan but can borrow more than the collateral is worth.
When you use investment accounts or a savings account as collateral, you typically won’t be allowed to let the value of the account drop below a certain level or you’ll be in violation of the terms of the loan agreement. This could trigger an immediate obligation to repay your loan if you don’t bring the account value up -- but your loan terms will specify exactly what occurs if this happens.
Consequences of defaulting on secured vs. unsecured personal loans
If you don’t pay an unsecured personal loan, a lender can try to collect in a number of different ways. The lender will report your delinquent payments to the credit reporting agencies, which will hurt your credit score. The lender will also likely contact you repeatedly to try to get paid.
Lenders may try to collect themselves or, after a certain amount of time has passed, may opt to sell the debt to a collection agency. The lender or collection agency could sue you, take you to court, and get a judgement against you. If you don’t pay the judgement, the lender could get a court order to enforce it by garnishing your wages or putting a lien on your property. All of this can take time for the lender and requires court visits and legal fees -- it’s not easy for the lender to be able to take your money or property.
On the other hand, with a secured loan, the lender has an interest in the collateral because of the way the loan is structured. It’s much easier to take the property that you pledged to guarantee the loan. Depending on loan terms and state laws, the lender may just be able to take the money in your savings or investment account when you default without any court action even required. Check your loan agreement to find the exact process for the seizure of your collateral.
Because it’s so easy for the lender to take the assets guaranteeing the loan, your property is at much greater risk if you don’t pay a secured loan. When you fail to pay a secured loan, the lender can also report the default to the credit reporting agency and ruin your credit just as lenders can with secured loans.
The difference between secured and unsecured personal loans
There are key differences between secured and unsecured personal loans. If you have bad credit or otherwise have a hard time qualifying for an unsecured personal loan, a secured loan could provide you with the funding you need. But be aware that a lender can more easily take your property on a secured loan than with an unsecured personal loan -- and you also have to tie up some of your assets to qualify for a secured loan.
By understanding these key differences, you can decide what type of loan to apply for and can maximize the chances of getting approved for a loan.
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