There are two primary loan types: unsecured and secured. Though both are loans and can have similar terms, which one you should get will depend on the reason you need financing.
And while you’ll generally find better pricing and terms with secured loans, there are plenty of situations where an unsecured loan will be the better choice.
Let’s drill down on this topic of unsecured vs. secured loans and see which will work better for you.
What’s Ahead:
Unsecured vs. secured loans – side-by-side summary
To help you better appreciate the differences between unsecured and secured loans, the table below summarizes the main features of each.
Unsecured loans Secured loans
Interest rates Lower Higher
Loan terms Generally no more than five years, except with credit cards Often ranges from five to as many as 30 years
Credit requirements Higher, typically with a minimum credit score of 650 Loans commonly available for lower credit scores
Installment or revolving? Can be either Can be either
Loan amounts More limited, based on credit score and income Typically tied to the value of the collateral
Consequence of default Lender implements a lawsuit against borrower Lender seizes collateral property
Common loan types Personal loans, student loans, credit cards Mortgages, home equity loans and lines of credit, auto loans
What is an unsecured loan?
As the name implies, an unsecured loan is one where you’re not required to pledge any collateral as security for the loan. Typical examples of unsecured loans include credit cards, personal loans, and even student loans.
Since unsecured loans have no collateral, they’re generally more difficult to qualify for. Qualification will be based on a combination of your credit history and your income. Lenders will want to know that you have success in managing other types of credit, as evidenced by a satisfactory credit score.
On the income side, the lender will want to know that you have stable employment. Guidelines will vary from one lender to another, but many lenders look for a satisfactory employment track record for at least the past two or three years.
Also on the income side, lenders will want to be sure the new unsecured loan will be well within your ability to carry. The common metric to make this determination is your debt-to-income (DTI) ratio. This is the total amount of monthly housing and debt payments you have, divided by your stable monthly income.
Lenders typically establish an upper limit on the DTI, which may be something like 40%, 45%, or even 50%. If your total monthly payments, including the loan you are applying for, exceed the DTI limit, the lender may not approve your application.
To get a sense of what your DTI may look like, check out the calculator below.
Examples of unsecured loans
Unsecured loans are available from multiple sources. Most banks and credit unions offer credit cards, and many also make personal loans available.
But the personal loan space has grown much more diverse in recent years, with lenders specializing in specific personal loan niches.
Examples include:
- Monevo. Monevo allows users to complete a single form and receive quotes from multiple personal loan lenders. Through Monevo, you can search loans from $500 to $100,000 for just about any purpose, and with nearly any credit score.
- LendingClub. LendingClub is practically synonymous with personal loans. They offer a huge range of loans available in amounts up to $40,000, with terms ranging from 36 to 60 months.
What is a secured loan?
As the name implies, a secured loan requires that you pledge collateral as a condition of the loan. Common examples include mortgages and home equity loans and lines of credit, auto loans, and certain business loans, just to name a few.
Because the loans are secured, and the lender has collateral to seize for repayment of the debt if you default, borrower qualifications tend to be somewhat more flexible. You can typically borrow more money with longer loan terms and more favorable pricing.
The perfect example is a mortgage. Because the loans are secured by your home, the lender will provide financing for up to 30 years. With a typical mortgage, the interest rate will be in the low single digits. And with some mortgage types, like jumbo loans, you can even borrow millions of dollars against your home or the house you plan on purchasing.
Auto loans or another prime example. Since the loan is secured by a vehicle, you may be able to borrow as much as 100% of the purchase price of a brand-new car. The security that comes from the vehicle as collateral makes this possible. And if you have at least average or good credit, you can expect to pay an interest rate in single digits.
Examples of secured loans
Secured loans are available from even more sources than unsecured loans. They’re common loans made by banks and credit unions but are often offered by other institutions.
For example, mortgage loans are commonly available through mortgage companies and mortgage brokers who deal only with home financing. The same is true with some car loans. There are companies that offer nothing but car loans and work closely with car dealerships. Some even specialize in car financing for buyers with poor credit.
And, increasingly, there are online sources offering secured loans. The advantage to using an online source is that the entire process can be completed on the company website, and often features competitive loan quotes from multiple providers. That increases the likelihood of getting a lower rate.
- OneMain Financial. OneMain has been helping people find personal loans in communities nationwide for over 100 years. Through OneMain Financial, users can take out a loan of $1,500 to $20,000 with loan terms of 24 to 60 months.
- Upgrade. Upgrade offers fixed-rate personal loans that can be used for just about anything, from credit card refinancing, to home improvement, to major purchases. With Upgrade, you can borrow as little as $1,000 up to as much as $50,000.
Who is an unsecured loan right for?
Borrowers with good credit
In most cases, unsecured loans work best for those who have average or better credit, stable income, and low debt-to-income ratios. If you are well within the qualifying ranges for each of those three criteria, it’s likely you’ll get the loan amount you need at a reasonable interest rate.
That doesn’t mean unsecured loans are strictly for those with good credit. There are lenders available that can accommodate borrowers with lower credit scores. But you must understand the loan amount you qualify for will be lower, and the interest rate you’ll pay will be higher.
Consolidating high-interest credit card debt
If you can qualify for an unsecured loan, it’s an excellent way to consolidate high-interest debt, particularly credit cards. But this is where good credit comes into the picture. If your credit score is high enough, you may be able to get a lower rate on a personal loan than you are currently paying on your credit cards.
That will not only save you money in interest, but you’ll also be able to pay the personal loan off in no more than three or five years. That can be the best way to eliminate credit card balances from your life permanently since the revolving nature of those arrangements can make them permanent fixtures in your life.
Financing for a new business venture
Obtaining financing for a new business is notoriously difficult. Because the business is a new one with no cash flow, lenders are understandably reluctant to make loans. While there are other alternatives, each comes with its own set of limitations.
For example, some new business owners use credit cards to finance the new venture. But these carry high rates and can leave you without ready credit sources for personal expenses.
The other common financing option is a home equity line of credit. While this is a low-interest financing arrangement with a potentially high loan amount, it puts a lien on your home. The failure of your business venture could also result in the loss of your home if you’re unable to make payments on the home equity line.
A personal loan may be the very best solution if you’re looking to launch a new business. You can borrow up to $40,000 – and sometimes more – with no collateral. And since the funds can be used for any purpose, you can use them to start your business.
Student loans
These are commonly the largest of all unsecured loans. Students often need tens of thousands of dollars to pay for college, and student loans are the preferred financing method.
Fortunately, you can qualify for federal student loans even if you have no income or established credit. But federal student loans have limited dollar amounts, which may require getting private student loans.
And once you graduate from college you may want to refinance those student loans to get the benefit of a lower interest rate and payment.
Who is a secured loan right for?
Homebuyers
Secured loans are a good choice for anyone who either owns property that can be used as collateral or needs financing to obtain it.
This is certainly the case when you’re buying a home. Few people have the funds to make a cash payment for a house, making financing a necessity. And fortunately, mortgage financing typically carries lower interest rates, making it affordable for a large number of people. And if you already own a home, you can refinance it to either get the benefit of a lower interest rate or to take out additional equity for other purposes.
Those looking to finance a car
Auto financing is another common reason for secured loans. Though autos aren’t nearly as pricey as houses, paying cash for a vehicle could easily drain your savings.
But much like mortgage financing, auto loans are typically available under very favorable terms. If you have at least average credit, you should be able to get an interest rate in single digits. And with good or excellent credit, you may even be able to get 100% financing on the vehicle you want to buy.
Summary
While unsecured and secured loans work differently from one another, they don’t necessarily compete with each other. Secured loans are primarily for asset purchases (or refinances), while unsecured loans are better for short-term financing, credit card consolidation, or even new business financing.
The one exception to the rule is student loans. They commonly carry larger loan amounts, with repayment terms over many years.
But whether it’s a secured or unsecured loan, the best rate and terms are always available for those with good or excellent credit. If your credit doesn’t fall into either category, you may want to spend some time improving it before you apply for either type of loan. That’ll be the best way to maximize the benefit of either loan.
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