How to Decide Between Secured and Unsecured Personal Loans
A personal loan is different because there are no restrictions on what you can use it for.
There are two different types of personal loan: secured and unsecured.
Learn the differences between them to see how you can choose the right one for you.
What is a Secured Personal Loan?
A secured personal loan is a loan that requires you to offer some form of collateral before you can receive the money.
A common example of a secured loan is a mortgage. You receive a loan to purchase a piece of real estate. That real estate acts as collateral for the loan.
If you are unable to pay the loan, the lender repossesses the real estate as compensation. The lender can then sell the real estate to make back the rest of the balance you owed.
Though you don’t have to use a secured personal loan to buy an asset that can be repossessed, you have to offer the lender some protection.
Often, you offer the balance of a savings account or CD as collateral to secure the loan.
When you apply for a secured personal loan, you’ll tell the lender how much money you’d like to borrow. The lender will look at your application and decide whether it should make the loan.
If the lender does decide to make the loan, it will decide how much collateral it will need. It will then tell you how you need to provide that collateral.
Often, you’ll be getting the loan from your bank. In that case, the bank will put a hold on your savings or checking account equal to the amount of collateral needed.
The money will stay in your account, earning interest, but you won’t be able to withdraw or use it.
The size of the loan directly affects how much collateral the lender will require you to offer.
Often, lenders will ask you to offer collateral equal to the amount lent. This ensures that the lender will not lose money. Other times, the collateral required is just a portion of the amount lent.
Where Can You Find One?
One of the most common places to get a secured personal loan is your bank.
You already have a relationship with your bank, which can make applying for a loan easier.
It’s also easy to offer collateral if you take out the loan from your bank since you can use your savings or checking account balance as the collateral.
Other types of lenders exist and can accept different types of collateral than your bank balance.
An auto title loan is a type of personal loan where your car serves as collateral.
A home equity line of credit (HELOC) is technically a secured personal loan since your home equity serves as collateral.
Technically, you can consider pawnshops to be secured personal loan providers. You bring something of value to the pawnshop and the shop gives you cash. The shop promises to hold the item for a certain period of time before putting it up for sale.
You can buy the item back from the shop later, thereby paying off the loan. The downside of these types of secured personal loans is they tend to have significant charges attached.
What Are They Used For?
You can use a secured personal loan for all sorts of things, but there are a few common uses.
One is for large home improvement projects. One benefits of offering collateral are that lenders will feel safer about lending you large sums of money.
That makes secured personal loans a great way to borrow a lot of cash for a big project.
Another common use of a secured personal loan is to rebuild your credit.
If you offer collateral equal to the amount you borrow, there’s no risk for the lender.
Having the loan appear on your credit report can give your score a boost if you make regular, on-time payments. You can use the money you borrowed to pay down old debts, further improving your credit situation.
Pro vs. Cons of Secured Personal Loans
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What is an Unsecured Personal Loan?
An unsecured personal loan is a loan that you receive without having to offer any collateral in exchange. Unsecured loans are riskier for banks, so they often require a more stringent application process.
Unsecured loans are riskier for lenders because the only guarantee they have that they’ll get their money back is your word.
If you go back on your promise to repay the loan, the bank can repossess the things you purchased to compensate.
This means that unsecured loans often require a higher credit score and have lower lending limits.
One common example of an unsecured loan is a credit card. You didn’t need to give the credit card company anything to open the account. You just applied and received the card. Every time you use the card to make a purchase, the card issuer is extending an unsecured loan to you.
Where Can You Find One?
You can get an unsecured personal loan from a wide variety of lenders.
As usual, the most common type of lender is a bank. When you apply for a personal loan from a bank, they’ll require a variety of information from you. The bank will use this info to assess how likely you are to repay the loan. The bank will then decide whether or not to offer the loan.
Because unsecured loans are relatively easy to administer, the lender just gives you cash and send you bills, many other types of lenders have emerged.
Payday lenders are an example of a non-traditional lender who offers unsecured personal loans. You should be very careful when using a payday lender as they often charge huge fees, making their loans very costly.
Peer-to-peer lending is another way to get an unsecured personal loan.
These websites post your (anonymized) loan information. Regular people who want to invest in personal loans can view your application and decide whether they’d like to contribute to your loan.
If you apply for a loan of $10,000, you might receive $100 from 100 different people. Each payment you make will be split among the 100 lenders.
Peer-to-peer lending lets people get loans from other regular people.
What Are They Used For?
Unsecured personal loans are useful in a number of situations.
One use of an unsecured personal loan is to consolidate your existing debts. Credit cards charge high interest rates, making it hard to pay them off.
Plus, you might be getting bills from five different cards at the same time. You can take out a personal loan at a lower rate and pay off all five cards.
You’ll save money on interest and only have to deal with one bill.
You can also use unsecured personal loans to meet unexpected expenses like car repairs or medical bills. They’re also useful for small home projects.
Pro vs. Cons of Unsecured Personal Loans
Which One Should I Use?
The type of loan that you choose depends entirely upon your credit and upon your goals for the loan.
A secured personal loan is best for rebuilding your credit. It requires you to put down collateral and you simply repay it to improve your credit score.
Otherwise, an unsecured personal loan is generally the better option for you. After all, if you had the money to put down for a secured personal loan, you wouldn't really need an unsecured personal loan to begin with.
They’re easy to apply for have moderate lending limits, and you don’t have to worry about having your collateral repossessed.