To be a smart borrower, it’s important to understand the loan options available to you. Most loans are either secured or unsecured. Here’s a breakdown of how each one works, common examples and more:
What are secured loans?
Secured loans are loans backed with something of value that you own, called collateral. Common examples of collateral include your car or other valuable property such as jewelry.
If you’re approved for a secured loan, the lender will hold the title or deed to the collateral or place a lien on it until you pay the loan off in full. If you don’t repay your loan, the lender may take possession of the asset, sell it and apply the proceeds to your outstanding debt.
Due to the use of collateral, the borrowing limits for secured loans are typically higher than unsecured loans. Secured loan rates could be lower as well. Common types of secured loans include mortgages and car loans.
What are unsecured loans and how are they different?
An unsecured loan is money you borrow without using collateral. With nothing of value backing the loan, the lender faces a higher level of risk. This can result in a lower borrowing limit, a higher interest rate and a higher credit score needed to qualify for the loan. Common examples of unsecured loans include credit cards and personal lines of credit.
Can a loan be offered secured and unsecured?
Some loan types, like personal loans, can be offered both as secured and unsecured. The need for collateral can depend on factors like the size of the loan and the borrower’s credit score and income.
Know before you borrow
Both loan types have strengths and weaknesses, which can vary per borrower and lender. If you plan to apply for a loan, make sure you have a clear understanding of the interest rate, monthly payment amount and repayment period before moving forward. By researching and comparing your options, you can find the best loan option for you.
*This article has been updated from its original posting in January, 2014.