Secured vs. Unsecured Loans: What’s the Difference?

Secured loans are backed by collateral, while unsecured loans aren’t. This presents different levels of risk for the lender, which results in different eligibility criteria and loan terms for you as the borrower. Generally, secured loans are easier to qualify for and offer better rates, whereas unsecured loans are harder to get and often cost more in interest.

How Secured and Unsecured Loans Work

Both secured and unsecured loans let you borrow money, provided you agree to repay the debt with interest according to an agreed-upon schedule. To qualify for either loan type, you must also submit to a hard credit check and provide personal financial documents that show you’re able to repay your debt, such as income statements.

However, a secured loan requires that you put down an asset as collateral for the loan. In other words, should you default, the lender may take possession of the asset to compensate for their loss.

What Is a Secured Loan?

A secured loan is a type of personal loan backed by collateral. Auto loans are one of the most common examples. In this case, the collateral is the vehicle being financed. Other kinds of secured loans include home equity loans, home equity lines of credit (HELOCs), secured credit cards, savings-secured loans, and other vehicle loans.

Pros & Cons of Secured Loans

Pros Explained

• Lower credit score requirements: Lenders are usually more willing to approve borrowers with poor credit if there’s collateral to fall back on.
• Higher borrowing limits: The more valuable the collateral, typically the greater the amount of money that a lender will let you borrow.
• Lower interest rates: Secured loans tend to have lower interest rates because the collateral offsets the borrower’s credit risk.

Cons Explained

• Risk of property loss: If you default on the loan, you’ll lose your collateral, which could be worth more than the loan balance. 
• Asset tied up: If you put down your savings or home equity as collateral, you may be unable to access it for the duration of the repayment period.
• Loan use restrictions: Many secured loans limit how you can use the loan funds. For example, a mortgage can only be used to pay for real estate.

What Is an Unsecured Loan?

Unlike secured loans, unsecured loans aren’t backed by any collateral. As a result, lenders who issue them typically weigh your credit and financial stability more heavily, and the amount you can borrow is usually lower. Common examples of unsecured loans include credit cards, lines of credit, personal loans, and student loans.

Pros & Cons of Unsecured Loans

Pros Explained

• No collateral required: You don’t need to put an asset on the line (though if you default, a lender can still sue you).
• Faster approval: Since there’s no collateral (or appraisal) involved, the loan approval process tends to be quicker. In some cases, you can walk away with a loan the same day you apply.
• Fewer use restrictions: You can get an unsecured personal loan for nearly anything (except things like gambling and illegal activities).

Cons Explained

• Stricter eligibility requirements: Compared to their secured counterparts, unsecured loans can be harder to qualify for if you have poor credit.
• Lower loan limits: Most unsecured loans are only available in amounts of up to $50,000, though some lenders may lend up to $100,000 in certain cases.
• Higher interest rates: To offset the lack of collateral, lenders tend to charge a higher interest rate, resulting in higher overall loan costs.

How to Choose Between Secured and Unsecured Loans

The right type of personal loan for you will depend on your goals, financial situation, and risk tolerance. For example, if you need a lump sum to pay for a variety of expenses, an unsecured personal loan may be the way to go because it gives you flexibility in how you can use it. Similarly, if you don’t own any assets, an unsecured loan may be the better (and potentially only) option.

Other common reasons to get an unsecured loan include consolidating debt, covering emergency expenses, funding major life events, and renovating your house. But remember, you can only borrow so much.

For higher-ticket purchases, a secured loan is often a better choice. For example, you’re unlikely to get a loan for a house—especially for a 30-year term—without offering the house as collateral. The same goes for a car. Plus, if you have poor credit, you’ll have a better chance of qualifying for a secured loan compared to an unsecured one. Other reasons to get a secured loan include locking in a lower interest rate or building your credit with a secured credit card. 

The Bottom Line

Secured and unsecured loans are two different ways that you can finance a variety of potential purchases. Carefully weigh the pros and cons of each to determine which best suits your situation before taking on this kind of debt.