SAN JOSE, California, September 28, 2021 / PRNewswire / – If you are planning to borrow money, you may come across secured and unsecured loans. While secured loans require some form of collateral, unsecured loans do not. This does not mean, however, that unsecured loans are always better.
Here’s what you need to know about secured and unsecured loans and how each can impact you as a borrower, from myFICO.
For more information on loans and credit, visit the myFICO blog at https://www.myfico.com/credit-education/blog
What is a secured loan?
A secured loan is a type of credit secured by collateral. If the borrower defaults on the debt, the lender can grab the collateral and use it to collect the amount owed.
Some types of loans are almost always secured, while others may or may not be, depending on your credit situation. Here are some common secured loans that you might come across:
Real estate loans: Mortgages are almost always secured by the property you are using to purchase the loan. Home equity loans and lines of credit are also secured against the equity in your home.
- Auto loans: The lender usually asks you to pledge the vehicle you are purchasing with the loan as collateral.
- Guaranteed personal loans: Sometimes referred to as shared collateralized or savings collateralized loans, these loans require you to hold a fixed amount of money in an interest-bearing account such as collateral for the loan. Depending on the lender, you can borrow up to 100% of the value of the collateral or less.
- Secure credit card: Secured cards require that you make an initial deposit, usually, but not always, equal to the credit limit that you are looking for on the card. In most cases, you will get the deposit back when you close the account, but some card issuers may return it before then if you use the card responsibly.
- Manufacturer credit: Designed specifically for people with bad credit, limited credit, or no credit at all, home builder loans work a little differently from other loans. Instead of giving you the loan proceeds up front, they are placed in an interest-bearing account while you make monthly payments. Once the loan is fully repaid, you will receive the funds.
Note that there are other types of secured loans, including auto title loans, pawn shops, and life insurance loans. But these are generally not recommended.
Benefits of secured loans
- May qualify with a lower FICOÂ® score: Many secured loans are designed for people with less than stellar credit. If you’re looking to build your credit, a secured credit card, secured credit loan, or personal loan can help.
- They usually come with lower prices: While this is not always true, secured loans often charge lower interest rates than their unsecured counterparts because the lender takes less risk.
- Larger loans: In some cases, the lender can afford to offer a larger loan amount because it is secured by collateral.
Disadvantages of secured loans
- It can be difficult to qualify for: In the case of a loan secured by savings or a secured credit card, it can be difficult to get approved if you don’t have enough money to meet the deposit requirements.
- The fault can be costly: It is never ideal to default on a loan. But if you default on a secured loan, you will likely lose the asset you pledged as collateral. With larger loans like mortgages and auto loans, foreclosure or repossession can be a real setback.
What is an unsecured loan?
Unsecured loans do not require any collateral of any kind. So while defaulting on payment can damage your FICOÂ® scores and sometimes lead to debt collection attempts, your assets will not be repossessed. Here are some common types of unsecured loans:
- Personal loans
- Student loans
- Credit card
There are other types of unsecured loans like payday loans, but it is better to avoid these.
Benefits of unsecured loans
- No warranty requirement: You don’t have to worry about having to find the money to get approval or losing a major asset if you can’t afford to pay off the debt at some point in the future.
- Competitive rates for borrowers with strong credit: If you have good or excellent credit, you may still qualify for a relatively low interest rate on an unsecured personal loan, student loan, or credit card.
- Quick financing: Since there is no need to transfer money for a deposit or do an appraisal on a secured loan, you may be able to access your loan funds faster with an unsecured loan.
Disadvantages of unsecured loans
- Usually more expensive: While you can get a competitive interest rate if your FICOÂ® scores are high, unsecured loans still charge higher interest rates on average than secured loans.
- No more limitations for borrowers with low FICOÂ® scores: If your credit history is rated as poor or limited, or if you have no credit history, you may face higher interest rates and fees, as well as lower loan amounts.
- Risk of lawsuit or recovery: With a secured loan, the lender can simply use the collateral to recoup his losses. But with an unsecured loan, they can sell the debt to a collection agency, who can try to sue you. While this doesn’t always happen, it’s important to make payments on time to avoid this possibility.
The bottom line
Both secured and unsecured loans have their uses and in some cases you may not have a choice between the two. While you can choose, there are also situations where one option makes more sense than the other.
The important thing is that if you are looking to borrow money, it is crucial to understand the terms of the loan as well as the pros and cons of the type of loan you choose, and to make sure you take the time to store lenders. Take the time to consider all of your borrowing options before choosing the one that best suits your needs.
myFICO makes it easier to understand your credit with FICOÂ® Scores, credit reports and alerts from the 3 bureaus. myFICO is the consumer division of FICO – get your FICO scores from the people who do the FICO scores. For more information visit https://www.myfico.com.