There are two types of loans: secured and unsecured. The former requires collateral, while the latter does not. As long as a loan, whether you need it to meet small emergencies or planned big expenses, does not require collateral, it is considered an unsecured loan. Collateral is not the only difference between both types of loans. This blog discusses how they are different from each other and which one is better.
The difference between secured and unsecured loans
Here is how secured loans differ from unsecured loans:
1. Collateral
Collateral means a valuable asset that you put down to secure your loan. No personal loans can be secured even if they are required to be paid down in fixed monthly instalments. The amount of collateral for secure loans is always worth more than the total cost of the debt.
It could be anything from a cash deposit to your house, but most probably, your house is secured against a loan. In the case of an auto loan, your car will be considered as security. If you fail to repay the debt on time, you will end up losing your assets.
2. The purpose of using money
Secured loans allow you to use them for a specific reason. For instance, if you are looking to take out a secured home improvement loan, you are entitled to use the debt only for home refurbishment. The same rule applies to a personal loan.
For instance, if you apply for an unsecured loan for a wedding, you cannot use this loan for any business purpose, but you are free to spend this money to meet any wedding-related expenses. If you take out loans for bad credit, you can use them for any purpose. Lenders do not put a restriction on the usage of these loans as they are small in amount and aimed at funding small emergency expenses.
3. Interest rates
Interest rates for personal loans are quite high in relation to secured loans. Personal loans involve a high risk. Lenders cannot access your personal property in case you make a default. Therefore, they charge high interest rates. It minimises their risk of losing money if they stop making payments.
However, secured loans carry lower interest rates as lenders can repossess your assets and liquidate them to cover their money back in case you cease payments.
4. Borrowing limit
Personal loans could be small or large, depending on the purpose of borrowing money. For instance, bad credit loans with no guarantor from a direct lender do not let you borrow more than £2,000. They are paid back in two or three months, depending on your repaying capacity. Large personal loans are paid back over a period of 18 months. However, it depends on a direct lender how much they could lend you. Some lenders cap on £10,000 while others cap on £20,000.
Lenders usually feel indisposed to lend you a larger amount of money without collateral. However, secured loans reduce the risk of lenders, and therefore, they are larger in size.
5. Qualification requirements
Personal loans and secured loans follow some common eligibility criteria. In addition to the basic criteria, you should have a good credit rating to apply for unsecured loans. Lenders are strict about credit score requirements when it comes to qualifying for an unsecured loan. Bad credit scores could get in your way of securing a secured loan. Lenders would require you to make a higher down payment.
Upsides and downsides of secured and unsecured loans
Here are the advantages and drawbacks of unsecured loans:
| Secured loans | Unsecured loans | ||
| Pros | Cons | Pros | Cons |
| Less stringent approval criteria | Non-payments will result in damaged credit score | No risk of losing your valuable assets | Interest rates are higher than secured loans |
| Affordable interest rates | You will lose collateral | Flexible repayment terms | Bad credit applicants can be turned down |
| Higher borrowing limits | Restrictions on the usage of loans | No restrictions on the usage of loans | Serious credit score damage in case of default |
Which is better – secured loans or unsecured loans?
The answer to this question is not so simple. No loan is good. Do not forget that you are to meet your obligations on time, and you are supposed to pay interest on top of the principal. You cannot choose between secured or unsecured loans because both types of loans come with different borrowing limits. It is not in your hands to make a loan secured or unsecured as and when you want. Lenders have their own policies, and they abide by them strictly when it comes to approving a loan application.
If you borrow a small amount of money, say, £1,000, it is not possible to secure them. No lender would ask you for collateral for such loans. For those who require you to put down a cash deposit, you should not borrow money from them. Such lenders can be loan sharks and unregistered. If you are looking to borrow a large amount of money, a lender’s policy will decide whether security is required or not.
At the time of borrowing money, you should carefully understand your needs. Make sure that you will discharge your debt on time so you do not lose collateral, nor do you lose your credit points.
The final word
The basic difference between secured and unsecured loans is the need for collateral. The former requires security, while the latter does not. In addition, secured loans allow you to borrow a larger sum of money than personal loans. They also charge lower interest rates in comparison.
No matter which type of loan you take out to meet your needs, you should always try to repay the debt on time. It will preclude you from losing your credit points and collateral.