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If you need to take out a personal loan, one of the first big decisions you will need to make is whether you want to use a secured or unsecured loan. There are many differences between the two, all stemming from one fact: a secured loan is secured by some kind of collateral (i.e. an asset you own) whereas an unsecured loan is not. is not.

What is a secured personal loan?

A secured loan gets its name from the fact that it is secured by collateral. This collateral can be anything you own and pledge to the lender. If you default on the loan, the lender can take back your collateral.

You are probably already familiar with secured loans from other areas of your life, such as:

The same idea works for a secured personal loan. If your lender allows it (and some don’t), you can pledge collateral, such as a car, savings account, or certificate of deposit.

Secured personal loans may be preferable if your credit is not good enough to qualify for another type of personal loan. In fact, some lenders do not have minimum credit score requirements to qualify for this type of loan. On the other hand, secured personal loans are more risky for you, because you could lose your property. If you give your vehicle as collateral and the lender takes it back, you may not be able to get to work.

A secured personal loan can:

  • Be easier to qualify. Secured personal loans are less risky for the lender, who can take possession of your collateral if you fail to repay the loan. In fact, some lenders may require you to use collateral if your credit score or other qualifications aren’t the best.
  • Be cheaper than other loans. Since secured personal loans are less risky for lenders, they often charge lower interest rates than other types of loans. Collateralizing your personal loan can be a way to reduce the overall cost of your loan. A resident of Texas, for example, may be able to secure a $10,000 24-month secured personal loan from Wells Fargo for 7.21%, more than two percentage points below the national average rate for unsecured loans.
  • Have higher borrowing limits. Lenders might be willing to let you borrow more money if they have a better chance of getting at least something back if you don’t pay. If you need to borrow a very large sum of money, it may be a good idea to use a secured personal loan.
  • Put your assets at risk. If you think you’ll end up defaulting on a loan, it’s never a good idea to take one out. This is especially true for secured personal loans, however. If you don’t pay, your lender can take your collateral.

What is an unsecured personal loan?

The truth is that most personal loans are unsecured, which means there is no collateral involved. If you don’t pay, the lender risks losing all the money they lend you. For this reason, they are riskier for the lender, which affects other characteristics of the loan.

Unsecured loans are also common in other areas of your life. These types of loan products are also considered unsecured loans because they are not backed by any collateral:

Before you can qualify for an unsecured personal loan, lenders will assess things like your credit score, your payment history on your credit report, and your income. Most lenders require a credit score of 670 to qualify for an unsecured personal loan.

An unsecured personal loan can:

  • be more difficult to qualify. Since there is nothing lenders can take immediately to pay off unpaid debt, they are less willing to lend money for unsecured loans. Unless you can demonstrate that you are more likely to repay the loan.
  • Have higher interest rates. Since lenders have no way to recoup their costs if you fail to repay the loan, they often charge higher interest rates. The interest rate on an average 24-month personal loan was 9.5% APR in May 2020, according to the Federal Reserve.
  • Have lower borrowing limits. Lenders tend to be more cautious with unsecured loans compared to secured loans. This is why you usually cannot get approved for such large amounts if you apply for an unsecured loan versus secured loans. You can take out a loan of a million dollars or more for a mortgage (secured by your home), but you’ll probably never be able to borrow that much using an unsecured loan.
  • Don’t lose your assets if you default early. If you default on an unsecured personal loan, there is nothing your lender can take immediately. But that doesn’t mean you’re completely off the hook. Your lender can still flag the loan as delinquent and ruin your credit. They can also put you in debt collection and sue you. If the judge allows it, they can even seize your wages. So while you won’t lose your bank account at first, eventually you’ll have to pay up one way or another.

Key Differences Between Secured and Unsecured Loans

Where to get a personal loan

Finding a personal lender is like finding a tree in a forest: they are everywhere. You can usually take out a personal loan from one of three different types of lenders.

Banks and credit unions

Most banks and credit unions offer personal loans. If you are looking for a secured loan, these lenders have the advantage as you may be able to use your existing savings account or CDs as collateral. Alternatively, for unsecured loans, it may be beneficial to shop around with multiple banks and credit unions.

It should also be noted that it may be easier to get a loan from credit unions, especially for people who may not qualify with other lenders. Credit unions are non-profit organizations that are generally more community-oriented than banks, so they may be more willing to work with you if you’re in a difficult situation.

Additionally, credit unions often have cheaper rates on personal loans, both secured and unsecured. For example, in June 2020, banks charged an average interest rate of 10.28%, while credit unions charged one percentage point less at 9.21%.

Online lenders

There are many personal lenders online. These loans are often quicker to obtain because you can usually complete the process entirely online. That’s fine, but it also means it can be harder to apply for a secured personal loan if you need one.

There are a few exceptions, but these lenders often require you to complete part of the application process in person. For example, they may need to physically inspect your warranty (like your car) if that’s what you’ll be using.

Related: Compare personal loan rates for 2020

Alternatives to Personal Loans

Personal loans aren’t your only options if you need to borrow money. Here are a few other types of loans you might be able to use, and when they might be best:

  • Credit card. It’s usually not wise to carry a balance on a credit card because they have such high rates. But there are cases where it can be a good idea, like if it has a 0% APR offer.
  • Medical payment plans. If you need medical care but can’t pay the full bill, you can often set up a payment plan with the billing service. These are usually very affordable and may even be free. Generous doctors may even waive your pay, but that’s not a guarantee.
  • Home equity loans or lines of credit. If you own your own home, you can often borrow money against the equity you have accumulated at an affordable rate. But remember: this is a secured loan, so if you default, you could lose your home.
  • Grants and loans for low-income people. If you’re on a low income, it’s worth checking with local community organizations to see if there are grants available for whatever you need. Depending on where you live and what’s available, you may be able to find affordable grants or loans to help with home repairs, prescription drugs and more.

About Judith J. George

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