When you’re planning a big purchase (a car or a house) or just need cash to help you through financial trouble, choosing the right type of loan is important.
There are two types of loans: secured and unsecured loan. The main difference between these types of loans is the presence or absence of a collateral, which is an asset that a lender accepts as security for a loan. It can be a car, a property, or other assets of value that are used to minimise the risk to the lender.
So simply put, a lender requires a borrower to offer collateral secured loan. In the event that the borrower is unable to repay the loan, the lender can use these assets to clear the outstanding balance, interest or fees.
Meanwhile, an unsecured loan does not require collateral, meaning that there is no security against the loan. In these types of loans, lenders focus on other financial aspects of the borrower to ensure that they are capable of repaying their loan (e.g. income, net worth, credit score etc)
To have a further understanding of these loans, we will discuss their features and break down their respective pros and cons.
What is a secured loan?
As the name suggests, a secured loan requires collateral. It means you are giving the lender a security that your loan will be repaid.
Usually, if you buy a car or a home using a secured loan, the item purchased can also be used as a collateral. For example, if you bought a property, the lender will hold the deed of the property until your mortgage is fully paid. If you are unable to pay back the loan, the lender has the right to seize the property and sell it and consequently, the borrower has given up the right of ownership over the house.
Other items or assets of value can be used to back a loan as well. According to Experian, here are some assets you can use as collateral for a secured loan:
However, remember that the lender may take into consideration the age, location and attributes of the collateral and you may be required to provide details of the assets so the lender can determine its current and future value.
A secured loan is the most common loan taken out by people planning to borrow large amounts of money. The most common types of secured loans are car loans, and mortgages. There are also secured personal loans available in the market.
Pros of a secured loan
Cons of a secured loan
What is an unsecured loan?
An unsecured loan is not backed up by collateral. Lenders take on a higher risk by giving out this loan, because the borrower does not provide an asset of value to offset their losses in case of default.
To determine if you will be capable of repaying your loan, lenders will usually judge you on these C’s of credit:
Examples of unsecured loans are credit cards, student loans, payday loans, line of credit loans and unsecured personal loans.
Advantages of unsecured loans
Disadvantages of unsecured loans
Which is better: unsecured or secured loan?
As with many financial decisions, it will depend on your objectives, financial situation and your personal circumstances.
If you are looking to borrow a big amount of money and you want a long-term period of payment, choosing a secured loan may be the right option for you. If you are planning to buy a house, renovating your property or other big purchases, then secured loans may be suitable for you.
Meanwhile, if you need cash for monthly expenses, emergency medical bills or any other short-term expenditures, unsecured loans may be ideal. The faster process of unsecured lending may make it more suitable for those requiring quick access to funds. However, remember that you have to pay high interest rates, so make sure to have a game plan on how to pay it in a timely manner.
You also need to consider the requirements of each type of loan. For example, you think you have no item or asset of value, then you should try applying for unsecured loans.