Secured vs. Unsecured Personal Loans: What’s The Difference?
Personal loans are usually unsecured. They are only backed by your promise to repay them—your “personal” guarantee.
If you are having trouble getting approved for an unsecured loan or you don’t like the interest rate the lender offers, you might be considering a secured personal loan, but it’s crucial that you understand how they work.
Secured personal loans are backed by collateral, an asset that the lender can repossess if you don’t repay the loan.
What Are Unsecured Personal Loans?
Unsecured personal loans are also called signature loans. The idea is that there is no car, house, boat, art collection, or other valuable asset for the lender to take from you if you don’t repay the loan. Most personal loans are of the unsecured variety.
So, if the lender can’t take your assets, how can it be sure that you’ll repay? Personal loan providers want to know that you’re both willing and able to repay them. Lenders evaluate applicants based on their credit history and score, which shows how they handled debt in the past, and their income, which proves that they are capable of repaying the loan.
Comparison of Secured and Unsecured Loans
The Best Personal Loan Rates Are at Your Fingertips
Finding the lender with the best personal loan to meet your needs is as simple as using our search tool. Compare personal loans and find the best rates being offered today.
Unsecured Personal Loan Rates
If you search for interest rates for unsecured personal loans, you’ll see that interest rates vary from roughly 6% to 36%. The reason rates for unsecured personal loans are so unclear is that they’re based on current loan rates in general as well as your specific credit profile. The lender has no idea what rate might be appropriate until it reviews your credit standing.
In practice, the rate you pay for an unsecured personal loan depends on two variables, both of which you largely control.
First, the better your credit, the lower your rate.
That’s because credit scores are closely related to delinquencies. Research by credit score pioneer Fair Isaac shows that individuals with credit scores of 800 and above have a delinquency rate of about 1%. However, the delinquency rate for those with credit scores between 580 to 669 is about 28%. That’s 28 times higher than individuals with top scores. As a lender, you would rather deal with borrowers who represent less risk.
The good news about credit scores is that you can control them. The best way to raise credit scores is to pay bills in full as soon as they are received. This will allow you to avoid late fees and credit dings.
Second, different lenders charge different rates. Given your credit profile, you need to shop around for the best personal loan rate.
Where to Find Unsecured Personal Loans?
Unsecured personal loans are widely available. Major sources include banks, credit unions, peer-to-peer lenders, online lenders, apps, and friends and family. To get the best deal on an unsecured personal loan, contact several competing providers and give them all the same information (loan amount, term in years, estimated credit score, income, and debts).
What Happens if You Don’t Repay an Unsecured Personal Loan?
Just because a loan is unsecured doesn’t mean lenders have no recourse if you walk away from the debt. Expect one or more of the following repercussions if you fail to pay as agreed:
- Late fees
- Damage to your credit report and score (30 days late or more)
- Calls for the lender’s collection department
- Your account sent to a collection agency
- A lawsuit and judgment
- Possible wage garnishment, bank account levies, and/or liens against your home
The bottom line: Never borrow what you cannot comfortably repay.
Alternatives to Unsecured Personal Loans
An unsecured personal loan may not be the right financial option for your situation. There are several alternatives to consider.
Credit Cards
Available to just about anyone with a pulse, credit cards are convenient, easy to use, and just about universally accepted. If you pay off credit cards each month, they are extremely useful.
However, if you allow balances to linger, you will pay. According to the Federal Reserve, the average credit card interest rate as of this writing was 16.88%.
Personal Lines of Credit
A personal line of credit is a preapproved loan that you don’t have to take unless you need it. Similar to credit cards, personal lines of credit are spending limits granted by lenders. If you accept a line of credit, you have the right to access cash at a future date. This might be a check, a transfer to your checking account, or a card.
Unlike fixed personal loans, personal lines of credit generally come with variable interest rates. But the beauty is that you only pay interest if you end up using the money. This makes them ideal for emergency funding.
Overdraft Protection
One of the best financial products for consumers is checking account overdraft protection. This is a line of credit that only kicks into action if you write checks that exceed your checking account balance. Instead of an overdraft – and overdraft fees – overdraft protection simply pays the check. You pay back the overdraft advance as quickly as possible – with interest. It’s convenient but can be very expensive.
Unsecured Loans to Avoid
Borrowing should be done with caution, and in some cases, it should be avoided at all. Payday loans and check advance loans are two forms of financing to avoid.
“The ads are on the radio, television, the Internet, even in the mail,” explains the Federal Trade Commission (FTC). “They refer to payday loans, cash advance loans, check advance loans, post-dated check loans, or deferred deposit loans. The Federal Trade Commission, the nation’s consumer protection agency, says that regardless of their name, these small, short-term, high-rate loans by check cashers, finance companies, and others all come at a very high price.”
How Do Payday Loans Work?
Payday loans are very short-term advances with very high fees. You might borrow $100 for 14 days, and to do it, you write the lender a check for $115. That’s 15% for two weeks. But what’s worse is that most borrowers roll over their loans repeatedly and pay another fee every time.
According to the Center for Responsible Lending, the average borrower rolls over the loan repeatedly (one 1% of borrowers take a single payday loan) and pays interest at a rate of 400% a year.
What Are Secured Personal Loans?
Unsecured personal loans can be a very good deal if you have a strong credit score and a well-documented credit report. But what if you’ve run into a tough financial patch? Lenders might want too much interest, or their loan terms may not be attractive.
What to do? Consider a secured personal loan. A secured personal loan – just like a mortgage – is backed by collateral. “Collateral” is an asset the lender can take if you don’t repay the loan.
Secured Personal Loan Interest Rates
Because an asset with a known value is involved, secured loans have interest rates a touch below 10% for individuals with credit scores around 600.
Like unsecured personal loans, your interest rate depends on your credit score (but to a lesser extent), your debt-to-income ratio (your income and debt picture determine your ability to repay the loan), and the value and liquidity of the collateral. Borrowing against property is much easier and less expensive than borrowing against a baseball card collection.
Where to Find Secured Personal Loans?
Secured personal loans are sold by mainstream lenders like banks, credit unions, and online lenders. Some lenders specialize in financing based on the type of collateral. For instance, some lenders will only lend against fine art, jewelry, or collectible automobiles.
What Happens if You Don’t Repay Secured Personal Loans?
It depends on the loan, the collateral, and the lender. If you had to put your coin collection in the lender’s vault, you won’t see it again unless you repay your loan. If you pledge property, you may go through foreclosure. If you pledge a car, you may find an empty parking spot when you get off work.
If there’s a good chance that you can’t repay a secured personal loan, you’re probably better off just selling the asset in the first place.
Secured Loans to Avoid
Secured personal loans have two sides. They can be useful for borrowers with limited choices. However, if unpaid, they can produce outsize negative consequences. Because of poor credit quality, the odds of default are significant for secured personal loans. The results can be especially damaging, especially for auto title loans.
Auto Title Loans
Having a personal loan secured by a car is an option to avoid for two reasons: cost and the potential for personal disruption.
According to the Federal Trade Commission, title loan lenders “often charge an average of 25 percent per month to finance the loan. That translates to an APR of at least 300 percent. It could be higher, depending on additional fees that the lenders may require. For example, if you borrow $500 for 30 days, you could have to pay, on average, $125 plus the original $500 loan amount—$625 plus additional fees—within 30 days of taking out the loan.”
Just on the basis of costs auto title loans should be avoided. But just as bad, and perhaps worse, is that auto title loans often make use of disruptive technology to enforce loan terms.
Think about what this means. A borrower with bad credit fails to pay an auto title loan for a few days. The lender disables the car. It doesn’t move. How does the borrower get to work to earn the money needed to repay the debt?
Alternatives to Secured Personal Loans
When considering a secured vs unsecured loan, there are only two reasons to choose a secured loan – because it’s cheaper or because you don’t qualify for unsecured financing. If you don’t qualify for a secured or unsecured personal loan, it’s time to start putting a few dollars aside each week until you have an emergency fund. Just $400 will probably keep you out of the clutches of payday and auto title lenders.
You can start this fund by selling off things you don’t need – eBay, garage sale, whatever. Take on a few extra hours at work or pick up a side gig. Get rid of the monthly app and entertainment charges until you have this money set aside. A temporary belt-tightening can start you on a better financial path.
Once you have your emergency fund, consider pledging some or all of it to get a secured credit card. Secured credit cards are not really credit, because the lender can take your money if you don’t repay. But they can help improve your credit rating and establish better habits, and eventually, the lender may increase your credit line or release your money.
How to Shop for a Secured Personal Loan
Secured personal loans are less common than unsecured personal loans, but the shopping process is the same. Contact several competing lenders—online, by phone, or in person—and provide them all with the same information.
That means the desired loan amount and term, an estimate of your credit score, debts and income, and the nature and value of your collateral. Review the offers you receive and choose the best rate and cost structure.
How to Apply for a Secured Personal Loan
Applying for a secured personal loan is not that different from applying for an unsecured personal loan. You’ll complete an application in person, by phone, or online, and the lender will check your credit and verify your debts and income.
The only difference is the collateral. You’ll have to prove its value and ownership. Requirements vary depending on what you’re offering as security.
Find the Right Loan for You
Not sure how much a loan will cost or which option is best for your financial situation? Use our Personal Loan Calculator to estimate your monthly payments and compare different loan scenarios.
Whether you’re considering a secured or unsecured loan, this tool can help you make a more informed decision before you borrow.
Secured vs. Unsecured Loan FAQs
Yes, you may still qualify for a secured loan even with poor credit, as the collateral reduces the lender’s risk. The collateral acts as security for the lender, making it easier to get approval compared to unsecured loans.
If you default on a secured loan, the lender has the right to seize your collateral. For example, in the case of a mortgage, the lender can foreclose on your home. Defaulting can also hurt your credit score.
Defaulting on an unsecured loan won’t result in losing any property since there’s no collateral involved. However, missed payments will harm your credit score, and the lender may pursue legal action to recover the debt.
When deciding, consider factors like interest rates, the loan amount you need, your credit score, and whether you’re comfortable putting up collateral. Secured loans may offer better terms, but unsecured loans are less risky in terms of losing assets.
Yes, some people take out secured loans, such as a home equity loan, to consolidate unsecured debt like credit cards or personal loans. This can potentially lower interest rates, but you risk losing your collateral if you default.
