Secured vs. Unsecured Personal Loans

Loans can be either unsecured or secured. Unsecured loans, also called signature loans, do not require collateral, such as your car, your home, or a savings account. Secured loans, on the other hand, require that you attach a valuable asset to the loan that the lender can seize if you default. Familiar types of secured loans include mortgages and auto loans, whereas most credit cards and personal loans are unsecured.

Whether you should use a secured or unsecured loan depends on your credit score, what assets you own, and what you're planning to use the money for. Before applying for a personal loan, make sure you understand how each type works to choose the best personal loan for your situation.

Pros and cons of secured and unsecured loans

How do secured loans work?

To get a secured loan, you'll either need to own an item that the lender will accept as collateral or the loan will need to be used to purchase the item that will be used as collateral. The value of the item often determines or affects the value of the loan.

In cases where the collateral needs to be appraised — like with a mortgage — loan approval and funding are typically contingent on the appraisal process, which can extend the timelines for both.

Secured loans are generally a type of installment loan, which means you'll make regular (typically, equal) payments. All secured loans risk collateral loss if you don't repay them. But since the lender is protected if you default, secured loans typically have lower interest rates than their unsecured counterparts. They may also be easier to qualify for.

Learn more about secured loans:

• Availability: Some online lenders offer secured loans, but it's more common for small banks and credit unions to offer them.
• Types of collateral: Real estate, a vehicle, a savings account, an investment account, and the appliances in your home are a few types of assets that may qualify as collateral.
• Borrower risk: Lenders may view secured loans as less risky because the lender can take ownership of your collateral if you default. In turn, interest rates are lower relative to unsecured loans. For example, the average interest rate on a 2-year unsecured personal loan was 12.33%, per the Federal Reserve. Meanwhile, a 60-month new car loan had an average rate of 8.40%.
• Eligibility: Lenders consider your credit, income, and employment history in addition to the value of your asset when assessing eligibility for a secured loan. The value of your collateral could mitigate a low income or low credit score, for example, making these loans easier to qualify for.
• Loan amounts: Secured loan amounts can be well over $100,000 depending on the type of loan, how much you qualify to borrow, and the asset's value.
• Down payment: When the loan is being used to purchase the asset that will be used as collateral, you're frequently required to contribute a down payment. For example, a mortgage purchase often requires a down payment of 20% to avoid private mortgage insurance (PMI).
• Variable vs. fixed: Secured loans may have variable interest rates, fixed or even both. For instance, an adjustable rate mortgage (ARM) may have a fixed rate for the first few years and then adjust to a variable interest rate.
• Repayment terms: Repayment terms on secured loans depend primarily on the loan's purpose. Mortgages, home equity loans, and home equity lines of credit (HELOCs) typically offer the longest repayment terms — up to 30 years or more. Auto loans and secured personal loans may be available for up to 7 years.
• Approval and funding time: Lenders must verify the asset's value, which can extend the approval period. While unsecured loans can be funded on the same business day of approval, secured loans with an involved appraisal process could take 30 days or longer to fund.
• Closing costs: If an independent appraisal is required, it could drive up closing costs. The more parties involved in closing the loan can also indicate higher costs.

How do unsecured loans work?

Unsecured loans aren't backed by collateral, which means the approval and funding processes are often faster. However, since the lender has no collateral to seize if you default, eligibility criteria tend to be stricter and rates higher.

Several types of loans can be unsecured, including personal loans, business loans, and credit cards. Note that credit cards are a type of revolving credit, whereas personal loans and business loans are typically installment loans.

Here is important information to know about unsecured loans:

• Availability: Banks, credit unions, and online lenders offer unsecured loans. Many online lenders have automated underwriting processes to speed up approvals.
• Lender risk: Unsecured loans are riskier for lenders, as they don't have an asset in place to back the loan. This increased risk is passed off to borrowers through higher interest rates, lower borrowing amounts, and stricter qualification criteria.
• Eligibility: Since lenders have less recourse if you default on an unsecured loan, eligibility criteria is tighter. Lenders generally prefer good credit or better (a FICO score of 670 or higher), a steady income and employment history, and a debt-to-income ratio (DTI) less than 36%.
• Loan amounts: Some lenders, like LightStream, SoFi, and BHG Financial approve well-qualified borrowers for unsecured loans up to $100,000. (BHG offers unsecured loans up to $200,000). But since rates on unsecured loans are higher, loan amounts are often lower relative to secured loans.
• Variable vs. fixed: Unsecured installment loans, like personal loans, tend to have fixed rates. Credit cards, which are a revolving form of credit, typically have variable interest rates.
• Repayment terms: Unsecured installment loans commonly have repayment terms of 2 to 7 years. But some lenders offer longer terms for specific loan purposes, like home improvement.
• Approval and funding time: Lenders don't need to evaluate collateral before approving and funding an unsecured loan. As a result, some lenders can fund unsecured personal loans the same day you apply.
• Closing costs: Unless you're assessed an origination fee, closing costs could be minimal to non-existent on an unsecured loan.

Related: Auto Loan vs. Personal Loan

Differences between secured and unsecured loans

The key difference between a secured and unsecured loan is that a secured loan requires collateral, while an unsecured loan doesn’t. 

The collateral serves as an insurance policy for the lender. If you fail to make your loan payments on a secured loan, the lender can seize your collateral, which could be your home, your car, money in your bank account, or something else of value, depending on the type of loan. For example, a mortgage is a type of loan secured by your home, as is a home equity loan, while an auto loan is secured by the car you drive. Personal loans, on the other hand, can be either secured or unsecured — and most are unsecured.

Securing a loan with collateral impacts the loan’s terms in both positive and negative ways. Generally speaking, a secured loan may be easier to qualify for or offer a lower rate, but you risk losing the asset you put up as collateral if you miss too many payments.

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Should you get a secured or unsecured loan?

Whether a secured or unsecured loan is the best option depends on what you'll use the loan for and your qualifications.

A secured loan may be more suitable if:

• You need a large loan and have an asset that is valued at or higher than the amount you want to borrow.
• You're buying something that requires a secured loan, like a vehicle or home.
• The loan's interest will be tax-deductible (for instance, if a loan secured by your home is used for home improvement).
• You haven't been able to qualify for an unsecured loan due to a low credit score or insufficient income.
• You're comfortable risking collateral for a lower interest rate.

An unsecured loan may be a better option if:

• You want the loan funded within the next day or two.
• You have an excellent credit score that qualifies you for a low interest rate.
• You don't have a valuable asset to pledge as collateral.
• You're worried about defaulting on your loan and potentially losing your asset.
• You want to reduce closing costs.

Prequalify with multiple lenders to compare potential repayment terms and interest rates for secured and unsecured loans without affecting your credit score. Once you formally apply for a loan, most lenders conduct a hard credit check, which can temporarily reduce your score by a few points.