As a borrower, there are a number of different loan types you can consider when in need of financing. The two primary types are secured and unsecured loans, each of which offering benefits and drawbacks. Learn everything there is to know about these two loan types to determine which is best for your needs.
What is an Unsecured Loan?
To those unfamiliar with the term, an unsecured loan is a loan that does not require any type of collateral on behalf of the borrower. Collateral is a form of security that reduces risk for a lender with a loan. Given that there is no collateral associated with an unsecured loan, the interest rate tends to be higher and the loan amount tends to be lower than some secured loan types.
Common Types of Unsecured Loans
There are a number of common unsecured loans that people borrow, with the most notable types including:
- Personal loans
- Student loans
- Unsecured credit cards
- Debt consolidation loans
What is a Secured Loan?
On the other hand, a secured loan is a loan that requires collateral in some form. Collateral can vary depending on the loan type, with some common forms of collateral being vehicles, homes, or general assets that a person owns.
For example, with a title loan, a person’s vehicle title serves as the collateral, with the lender taking possession of the title until you pay off the loan. If you fail to repay the loan, then a lender has a legal right to take possession of that collateral.
Common Types of Secured Loans
As with unsecured loans, there are a number of common secured loans that a person can choose to borrow including:
- Title loans
- Auto loans
- Mortgage loans
- Home equity loans
- Home equity lines of credit
Differences Between Secured and Unsecured Loans
The presence of collateral is not the only primary difference between secured and unsecured loans. There are three primary categories in which secured and unsecured loans differ:
Generally, secured loans will have higher borrowing limits as there is less risk to the lender. For example, a mortgage loan can be for millions of dollars in order to purchase a house, but that house serves as collateral.
On the other hand, unsecured loan types such as personal loans, will only have loan values ranging from $1,000-$100,000 on average.
The tenor of a loan is how long a borrower has to repay the loan. Typically, unsecured loans will have tenors ranging from two to seven years on average. Secured loans, on the other hand, can go for decades.
A mortgage will often have a tenor of thirty years and auto loans will often have a tenor of seven years. Some secured loans will have tighter turnaround times, such as title loans or payday loans which have tenors of thirty days or until your next paycheck respectively.
Loan Interest Rate
Finally, another key way in which secured or unsecured loans differ is the interest rate that comes with the loan. Generally, unsecured loans come with a higher interest rate considering the lack of added security in the form of collateral, whereas secured loans will have a lower rate.
Factors to Consider Before Borrowing a Loan
Before making a decision to take out a secured or unsecured loan, there are a number of factors you should keep in mind. Most notably, remember the following:
- If you fail to repay the loan you are borrowing, then the collateral you put up will be taken by the lender.
- Just because an unsecured loan has a higher interest rate doesn’t mean it’s worse than a secured loan with a lower rate.
- Avoid taking out more money than the exact amount you need based on the intended purpose.
- Consider if there is a specialty loan type for your purpose, rather than using a generic loan such as a personal loan for an auto purchase instead of an auto loan.
- Always budget for the monthly payments associated with a loan to be sure you can afford it.
Meet your emergency expenses today
Working to meet your financial expenses can be challenging if you don’t have access to cash at a given point in time. However, taking out a loan can give you quick access to the funds you need.
Unsecured loans work best for smaller expenses, such as home repair, whereas secured loans tend to work better for major purchases such as auto or home purchases.