Secured vs Unsecured Loan: Which is Better?

When you need money, you have several options, depending on your financial situation. If you have collateral or a valuable asset to use as collateral, a secured loan may be an option. If you don’t have collateral or don’t want to risk it, an unsecured personal loan may be a choice.

The key is understanding how each loan works, what’s required to qualify, and the loan’s total cost. Choosing an unsecured or secured loan is a big decision, so here’s what to consider.

Secured Loan vs. Unsecured Loan

Secured loans require collateral, and unsecured loans do not. Lenders often charge higher interest rates on unsecured loans because the lender doesn’t have any collateral to use if you don’t follow the repayment terms. Loans without collateral attached may also have lower loan amounts because of the risk lenders face.

Borrowers often use secured loans to purchase a house or car. They can also use them when they need money for personal reasons but don’t have good credit. In these cases, they use assets they already own as collateral. The collateral reassures lenders that they won’t lose money if you stop making your payments.

How Does a Secured Loan Work?

A secured loan requires collateral, to qualify for funding. If the borrower cannot repay the loan, the lender can repossess the asset to compensate for the loss of funds. Because these loans have collateral, they may have more flexible qualifying guidelines.

How to Qualify

Lenders need several documents to qualify for a secured loan, including your pay stubs, W-2s, bank statements, and approval to pull your credit reports.

With this information, they will evaluate the following to see if you qualify:

• Credit scores: Lenders look at your credit scores and credit history. They determine if you make timely payments and use your credit responsibly (don’t overspend).
• Debt-to-income ratio: Lenders calculate the total amount of your monthly debt to your monthly income. Each loan has a maximum debt-to-income ratio that allows them to reduce their risk of a loss.
• Asset value: Lenders consider the fair market value of the asset you’re using as collateral. They need to know this in case you don’t make the required payments, and they repossess the collateral.

What Credit Score is Needed for a Secured Loan?

Each lender has different credit score requirements depending on the loan type. For example, mortgage loans require a minimum credit score of 620, and auto loans require a minimum credit score of 661 for the best rates.

Both loans may be available with lower credit scores. However, you’ll pay higher interest rates and fees if you have bad credit.

What are the Risks?

A secured loan has several risks to consider, including:

• Risk of loss of collateral if you don’t make the required payments
• Damage to credit score if you don’t make the required payments
• Approval can take longer since lenders must determine the collateral’s value

Examples of Secured Loans

• Mortgage: You borrow a mortgage to buy a house. The house is the loan’s collateral. Lenders can repossess the home if you don’t make your payments.
• Car loans: You borrow a car loan to purchase a car. These installment loans use the car as collateral, and lenders can repossess it if you don’t pay.
• Title loans: You borrow a title loan when you have a financial emergency and need cash fast. These loans use your car as collateral and can repossess the vehicle if you miss payments.
• Home equity loans: These loans use your house as collateral but not for a purchase. Instead, you borrow money from the home’s value for home improvements or unexpected expenses.

Pros and Cons of Secured Loans

Pros of Secured Loans	Cons of Secured Loans
Often has lower interest rates than unsecured loans	You risk losing your collateral if you don’t make your payments
May be able to borrow higher loan amounts than unsecured loans	The application process can take longer than unsecured loans
May be easier to borrow with a lower credit score because of the collateral	Ties your asset up until you pay the loan in full

---

How Does an Unsecured Loan Work?

An unsecured loan doesn’t require collateral like a secured loan. Instead, lenders rely on your credit scores, income, and overall financial situation. Most lenders charge higher interest rates on unsecured loans because of the lack of collateral. If you don’t repay the loan, they have nothing to repossess.

How to Qualify?

To qualify for an unsecured loan, lenders consider factors similar to those of a secured loan, except for the value of the collateral since it’s not required. Lenders will pull your credit reports and ask for proof of your income. They need proof you can afford the monthly payments, including the higher interest rates they often charge for unsecured loans.

What Credit Score is Needed for a Secured Loan?

On average, lenders require credit scores of 610 to 640 for unsecured personal loans. However, you’ll get better rates and terms if you have a score of at least 670. You may find subprime lenders that offer unsecured loans for lower credit scores or credit card companies that give small credit lines for lower scores.

What are the Risks?

The main difference between a secured and unsecured loan is the lack of collateral, so the risk for borrowers is lower. You don’t risk losing assets. However, like secured loans, if you miss a payment, it can affect your credit score.

Examples of Unsecured Loans

• Personal loans: These loans are funds you can use for any purpose. You don’t use collateral to borrow them and can use the funds for any purpose. Common examples include debt consolidation, home improvements, or other expenses.
• Credit cards: Most credit cards are unsecured and are a revolving credit line that you can use to make purchases. You’ll pay interest on the charges and must make at least the minimum payment required.
• Student loans: These funds help you pay for college and often have different terms, including a grace period that doesn’t require any payments while in college. These loans can be for students or parents.

How to Choose a Secured vs Unsecured Loan

When choosing between secured and unsecured loans, consider the following factors:

• Collateral: Consider whether you have collateral to put up for the loan and if you’re willing to risk it. For mortgage or auto loans, your only option is to use the house or car as collateral, but other loans may have the option to be secured or unsecured.
• Interest rates: Depending on the lender, secured loans may have lower interest rates. Compare the interest rates offered on both loan types to determine which is best. Look at the total cost of the loan over the life of the loan to decide which is best.
• Speed of approval: The reason you need the funds will determine if a secured or unsecured personal loan is best. Lenders often approve unsecured loans faster because there isn’t any collateral to value, but each lender differs.
• Uses: Consider why you need the funds when looking at secured and unsecured loans. Some things, like buying a house or car, have specific loan requirements. Other uses may allow flexibility between secured and unsecured debt.

FAQ

Final Thoughts: Which Loan is Better For You?

A secured loan is usually best if you’re making a large purchase. You’ll get lower interest rates and be able to borrow more money. However, an unsecured personal loan may be better if you are in a bind or just need a small amount of cash fast.

The key is determining why you need the funds and considering whether lenders will approve you. A title loan may be an option if you’re in a financial bind and need money fast but have bad credit. Our professionals can help you understand how title loans work to determine if they’d be a good fit. Contact us today to learn more.