How Secured Loans Are Different From Unsecured Loans
Should You Take Out a Secured Loan?
Anytime you borrow money from a bank, or even an individual, you're taking out a loan. The lender may allow you to borrow the money with only your promise to pay it back. Or, the lender may require that you use an asset as security for the loan. This basic distinction is the difference between secured and unsecured loans.
What Are Secured Loans?
Secured loans are loans that are backed by an asset, like a house in the case of a mortgage loan or a car with an auto loan.
This asset is collateral for the loan. When you agree to the loan, you agree that the lender can repossess the collateral if you don't repay the loan as agreed.
Even though lenders repossess property for defaulted secured loans, you could still end up owing money on the loan if you default. When lenders repossess property, they sell it and use the proceeds to pay off the loan. If the property doesn't sell for enough money to completely cover the loan, you will be responsible for paying the difference.
What Are Unsecured Loans?
The same isn't true for an unsecured loan. An unsecured loan is not tied to any of your assets and the lender can't automatically seize your property as payment for the loan. Personal loans and student loans are examples of unsecured loans because these are not tied to any asset that the lender can take if you default on your loan payments.
You typically need to have a good credit history and solid income to be approved for an unsecured loan.
Loan amounts may be smaller since the lender doesn't have any collateral to seize if you default on payments.
Credit Reporting With Secured and Unsecured Loans
Lenders can (and do) report payment history of both types of loans to the credit bureaus. Late payments and defaults with both types of loans can be listed on your credit report.
With secured loans, the lender may go use foreclosure or repossession to take the asset tied to the loan. These may result in additional negative entries being added to your credit report.
Why Choose a Secured Loan?
With the risk of having your property seized if you don't repay the loan, you might wonder why anyone would choose a secured loan. People sometimes choose secured loans because their credit history will not allow them to get approved for an unsecured loan. Because secured loans are backed by assets, lenders have lower risk in extending a loan to you.
Secured loans also allow borrowers to get approved for higher loan limits. Even though you may qualify for a larger loan, you still must be careful to choose a loan that you can afford. When you’re choosing secured loans, make sure you pay attention to the interest rate, repayment period, and monthly payment amount.
With some loans - a mortgage or auto loan - the lender won't approve your application unless they have permission to take possession of the property if you default. Some loans are secured by design - this includes title loans and pawn loans.