Unsecured vs. Secured Loan: Understanding the Differences

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Published January 22, 2024

The main distinction between secured and unsecured loans is the collateral assets lenders use as security against loan nonrepayment. Secured loans offer larger amounts at lower rates but risk property. Alternatively, unsecured loans pose no property risk but have generally higher interest rates. 

In this article:

Differences between secured and unsecured loans
What is a secured loan?
Secured loan examples
What is an unsecured loan?
Unsecured loan examples
Secured vs unsecured debt: Which should you get?
Manage your credit profile with TransUnion®

 

Unsecured vs secured loans — what’s the difference? A secured loan is backed by collateral, such as property or assets, while an unsecured loan is not backed by specific assets, relying on the borrower’s credit score factors.

In this guide, learn more about the differences between unsecured and secured loans, how to determine which type is best for you and tips for paying down these types of debt.

Key Takeaways:

  • A secured loan is backed by collateral (such as cars and homes), has lower interest fees and has more flexible credit score requirements
  • Unsecured loans are not backed by collateral, carry higher interest rates and require a higher credit score
  • Unsecured loans offer more flexibility with how you can spend than secured loans
  • Both types of loans can impact your credit score if repayment requirements aren’t followed

 

 

Differences between secured and unsecured loans

The main differences between secured and unsecured loans are collateral requirements, the associated risk for the borrower and lender and the terms of the loans. Below is a breakdown of the key distinctions:

Table 1
Feature Secured loans Unsecured loans
Collateral Requires collateral, such as property, vehicles or assets Collateral is not required
Types of loans Mortgages, auto loans, HELOC Personal loans, credit cards, student loans
Risk to borrower Higher risk to personal assets as lenders may seize collateral if repayment fails Less risk to personal assets, but missed payments risk impact on credit score 
Interest rates Lower rates due to collateral Higher rates usually due to higher risk for lenders
Loan amounts May offer higher loan amounts with lower monthly payments based on collateral value Usually lower loan amounts than secured loans
Credit requirements More accessible to borrowers with lower credit scores Typically requires good to excellent credit scores
Approval process May involve a more extensive application and appraisal process Generally quicker approval process 

What is a secured loan?

A secured loan is backed by collateral — an asset the borrower pledges to the lender as security in case of default. This collateral could include assets like your:

  • Car
  • House
  • Bonds
  • Stocks

If the borrower cannot repay the loan, the loan lender can seize the collateral to make up for the outstanding funds.

In return for using collateral, secured loan lenders often offer a high loan amount, longer repayment periods (depending on the loan type) and a lower credit score minimum. This option is ideal for those who don’t have strong credit and need to make a large purchase.

Borrowers of secured loans should make sure that they can afford to make regular, timely payments for the loan amount they receive.

secured loan considerations

Secured loan examples

Common secured loan examples include:

  • Mortgage loans: A mortgage is a secured loan that helps finance real estate purchases, and the property being purchased acts as collateral in return for the loan. A common mortgage repayment period is 30 years.
  • Home equity loans: A home equity line of credit, HELOC, allows homeowners to use their homes as collateral in return for a cash amount based on their home’s value. These loans usually have repayment periods of 10 to 15 years.
  • Auto loans: When borrowers finance a car purchase, the car itself serves as collateral for the loan. Car loan repayment periods typically span from 3 to 7 years.

What is an unsecured loan?

An unsecured loan is a loan that is not backed by collateral, so the borrower does not have to pledge any assets to receive loan funds. These funds typically help finance short-term financial needs like student loan and credit card payments, as well as emergency and personal financing.

Since these loans are not secured, lenders rely heavily on the borrower’s credit risk and financial stability to help manage their risk.

Since there isn’t collateral backing the loan should it not be repaid, lenders may compensate for this additional risk by charging higher interest rates (but not always) and typically require credit scores that are in the good or excellent range.

secured vs unsecured debt interest rate differences
Finance rate on new autos at commercial banks, 48 month loan for August 2023, was 8.30%, according to the federal reserve. Finance rate on personal loans at commercial banks, 24 month loan for August 2023 was 12.17, according to the federal reserve.

However, if borrowers fail to meet loan requirements, lenders can implement hefty late fees and even involve debt-collecting agencies. For example, the lender can either send the late account to their internal collections department or sell the account to a debt collections agency. This can impact your credit score and stay on your credit report for 7 years.

unsecured loan considerations

Unsecured loan examples

Below are some common examples of unsecured loans:

  • Credit cards: Credit cards are a form of revolving credit that allows users to make purchases up to a predetermined credit limit and are the most common forms of unsecured credit.
  • Student loans: Student loans are designed to help students cover education costs. They often have deferred repayment options while the borrower is in school.
  • Medical loans: Unsecured loans can cover medical expenses, including procedures, surgeries or other health care costs.
  • Personal loans: Personal loans are a versatile type of loan that you can use for various purposes, such as debt consolidation, home improvements or unexpected expenses.

Secured vs unsecured debt: Which should you get?

The better choice between secured or unsecured debt depends on various factors, including your financial situation, goals and the purpose of the loan. Here are some key considerations that can help you determine whether a secured loan is best for you.

Potential impacts on credit score

Secured and unsecured debt have similar impacts on your credit score. For example, when applying for both types of loans, your credit report will typically receive a hard inquiry, temporarily reducing your credit score. Pro tip: If you’re in need of a loan, then it’s good to apply over a short time frame so that it can help limit the negative impact to your credit score. Also note that while only hard inquiries affect your credit score, all inquiries stay on your credit report for two years. Fortunately, hard inquiries will likely have only a small impact on your credit score. One way you can build back your credit health is by consistently making on-time payments. Missing these loan payments can negatively impact your credit and accrue late fees.

Collateral requirements

If you choose unsecured debt, you don’t have to worry about putting your assets at risk since there are no collateral requirements.

For example, if you fail to make payments on a secured loan, the lender can force you to sell back collateral, which is likely your home or your car. If you fail to make payments on an unsecured loan, the lender can report you to the credit bureau and eventually might sell your account to a debt collector agency.

Note: While there isn’t any asset attached to an unsecured loan, there still could be risk to your assets if that loan goes unpaid. It is possible that a lender could take legal action to get a court judgment. For example, if granted, then the lender could decide to garnish wages or put a lien against your house.

risks of failing to pay unsecured or secured debt

Interest rates

Lenders are at less risk with secured loans since they have your property as collateral. In exchange, lenders will typically offer lower interest rates for secured loans. The interest rates will depend on the type of loan you get approved for.

Interest rates covering the period 1985-2023, according to the Federal Reserve

Alternatively, unsecured loans carry higher interest rates since the lenders are at more risk. For example, the average interest rate for credit cards in August 2023 was 21.1%, according to the Federal Reserve.

Takeaway: Secure loans may have lower interest rates (but not always) than unsecured loans.

Approval process

Typically, unsecured loans have faster and easier approval rates, and secured loans have stricter approval criteria. For example, applying for a credit card (unsecured) will be faster than applying for a mortgage (secured) since the mortgage process requires extra steps like appraisals.

During the application process, secured loans don’t require as high credit scores as unsecured loans since the borrower is taking on more risk with their collateral. Unsecured loans will usually require excellent or good credit scores since the lender is appraising risk primarily on the borrower’s credit profile and finances.

Takeaway: Consider unsecured loans if you’re looking for a quicker approval process.

Flexibility

When comparing the two, secured loans offer less flexibility than unsecured loans. You can use unsecured loans for various purchases like you would with a line of credit on a credit card.

Secured loans are less flexible since they’re usually limited to the collateral you give to the lender, like your car or home.

Takeaway: If you want more flexibility with how you use your funds, you may want to choose unsecured loans.

Manage your credit profile with TransUnion

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TransUnion Credit Monitoring helps keep you informed, so if you need to act fast, you can.

With TransUnion Credit Monitoring, can review your VantageScore® 3.0 credit score anytime, anywhere. Score updates are available daily. Plus, you can get actionable steps to discover your credit health potential with CreditCompass™.

To help you stay on top of your credit profile, you get alerts when there are critical changes to any of your accounts that are reported to TransUnion such as hard inquiries from lenders, a credit card balance increase, or negative information like a late payment reported by one of your creditors. And with 24/7 access to your credit report, which can be refreshed daily, you can review your credit history, secured and unsecured debt balances, and personal information to monitor changes and to help identify any potential inaccuracies.

Additionally, you can get a debt analysis. Our tool shows you how much of your self-reported income is used to pay your debt that is contained on your credit report. Lenders may often look at this ratio to determine how much additional debt you can handle. Although different types of loans may have different DTI requirements, it’s always a good idea to keep your DTI ratio as low as possible.


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