Secured And Unsecured Loans - What You Need To Know
All debt broadly falls into two categories: secured and unsecured. Secured debt requires a borrower to pledge an asset to guarantee the loan, whereas unsecured debt does not. Understanding the difference between the two, as well as their pros and cons, is important.
What Is a Secured Loan?
A secured loan is any loan that requires the borrower to commit an asset of some kind to guarantee the loan. The most common types of this debt type include mortgages, home equity lines of credit, and vehicle loans. Should the borrower fail to pay back their loan, the lender is legally entitled to put a lien on whatever item was offered as collateral, allowing them to liquidate the asset to recuperate any losses.
-Who Can Use A Secured Loan? As previously mentioned, certain loans such as mortgages, HELOCs, and vehicle loans are by nature secured loans. Some individuals with poor credit may be required to provide collateral to secure loans which traditionally don’t require guarantees such as credit cards, lines of credit, and personal loans.
-How Do Secured Loans Work? The basic premise of this type of loan involves using an asset of relative value to the size of the loan to guarantee it. For example, an individual may apply for a LendingClub loan for medical expenses, hoping to cover part or all of their medical expenses. Depending on their credit score, they may be required to secure the loan with an asset of some kind. Should they default on their loan, the lender will seize the asset before selling it to make up for the unpaid loan balance.
What Is An Unsecured Loan?
An unsecured loan is any debt in which the presence of a guaranteeing asset is non-existent. These loans are granted based solely on the borrower's creditworthiness and financial situation. The most common forms of these financing options include credit cards, personal lines of credit, and student loans.
-Who Can Use An Unsecured Loan? These loans are very common, and can be used by anyone who needs access to credit. The most common form of unsecured debt are revolving lines of credit, usually in the form of credit cards.
-How Do Unsecured Loans Work? When an individual applies for debt that isn’t secured, they are granted an interest rate and credit limit based on their credit score and history. Unlike secured debt, there is no collateral used to secure the loan. Should the borrower default on their loan, there is no asset for the lender to repossess, but that doesn’t mean the lender won’t try to collect.
The Pros And Cons Of A Secured Loan
-Lower Interest Rates: Because secured loans are guaranteed with collateral, they present a lower level of risk to the lender, meaning lower interest rates for the borrower.
-Longer Terms: Secured loans typically come with longer terms than their unsecured counterparts. For example, secured SoFi medical loans have much longer repayment terms than comparable unsecured options.
-Larger Sums Of Money: Secured options offer borrowers access to larger sums of money than unsecured financing.
-Allows Individuals To Improve Credit: Those with a poor credit score may not have access to unsecured debt and will need to pursue secured debt vehicles. This will allow them to rebuild their credit.
-Potential Loss Of Property: The biggest downside to secured debt is the potential loss of the collateral asset. If a borrower pledges their home as the guarantee for a medical loan, failure to pay off the debt can result in the lender taking ownership of the property.
-Longer Approval Times: Most forms of unsecured debt, such as those available from Upstart Loans, can be approved within a few hours. Secured financing, on the other hand, takes much longer to approve due to the complexity of the paperwork.
The Pros And Cons Of An Unsecured Loan
-No Loss Of Property: Because unsecured debts aren’t backed by an asset, the lender has nothing to repossess should the borrower default on their loan. While defaulting will result in negative consequences for one’s credit score, there is no chance the borrower can lose their property.
-Fast Approval Times: Approval times for unsecured financing are much faster than with secured options. Some online lenders can even approve loans in as little as a day.
-Can Be Absolved Through Bankruptcy: Under a Chapter 7 bankruptcy filing, all unsecured debt is effectively discharged, leaving the borrower free of any unsecured balances they had outstanding. The same cannot be said for secured debt.
-Higher Interest Rates: Unsecured options present a higher degree of risk for the lender since there is nothing to guarantee the loan. Due to this reality, unsecured loans typically come with higher interest rates than secured debt.
-Lower Amounts: Lenders aren’t willing to offer large sums of money, such as those required to purchase a property, through unsecured financing. Typically, unsecured loans are either revolving lines of credit or lump sum loans with a limit that reflects the borrower's income.
Which One Is Right For You?
Deciding between secured and unsecured debt depends largely upon what a borrower is attempting to finance, the stability of their financial situation, and the interest rate they are comfortable with.
For large, long-term loans, secured debt is preferred because of its lower interest rates. For smaller, revolving debts, unsecured financing is preferred because even if the borrower defaults, there are no assets the lender can seize.
Borrowers need to understand the difference between secured and unsecured debt, along with their respective advantages and disadvantages. Failure to do so can result in an individual pursuing the wrong type of financing, possibly costing them much more over the long run.