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While some people swear by a cash-only lifestyle, the truth is, most of us rely on credit to pay for life’s big expenses over time. When you want to buy an expensive item like a house or a car, open or expand a business, renovate a kitchen, or pay for your education, you can apply for a loan at your local office or online to help cover the costs. .
When considering your credit options, you may have to choose between a secured loan and an unsecured loan. Secured loans require you to offer something that you own of value as collateral in case you cannot repay your loan, while unsecured loans allow you to borrow money directly (after the lender has considered your financial data).
There are pros and cons for both types of loans, so before deciding anything, it is best to understand the conditions attached to it.
What is a secured loan?
A secured loan is a loan backed by collateral. The most common types of secured loans are mortgages and auto loans, and in the case of these loans, the collateral is your house or your car. But in reality, collateral can be any type of financial asset that you own. And if you don’t repay your loan, the bank can seize your collateral in payment. A repossession stays on your credit report for up to seven years.
When you take out a secured loan, the lender puts a lien on the asset that you offer as collateral. Once the loan is paid off, the lender removes the lien and you own both free and net assets.
Here are the types of assets you can use as collateral for a secured loan, according to Experian:
- Bank accounts (checking accounts, savings accounts, CDs and money market accounts)
- Vehicles (cars, trucks, SUVs, motorcycles, boats, etc.)
- Stocks, mutual funds or bond investments
- Insurance policies, including life insurance
- High-end collectibles and other valuables (precious metals, antiques, etc.)
Secured credit cards, such as Capital OneÂ® Secured MastercardÂ® and First TechÂ® Federal Credit Union Platinum Secured MastercardÂ®, are another example of a secured loan. The collateral, in this case, is the money you deposit (often a refundable deposit of $ 200) that serves as the initial credit limit. You get your deposit back when you close the account.
Because your assets can be foreclosed if you don’t pay back your secured loan, they are arguably riskier than unsecured loans. You always pay interest on the loan based on your creditworthiness and, in some cases, fees, when you take out a secured loan.
Don’t miss: The best secured credit cards of October 2020
What is an unsecured loan?
An unsecured loan does not require any collateral, although you will be charged interest and sometimes fees. Student loans, personal loans, and credit cards are all examples of unsecured loans.
Since there is no collateral, financial institutions provide unsecured loans largely based on your credit score and your debt repayment history. For this reason, unsecured loans can have higher interest rates (but not always) than a secured loan.
Unsecured personal loans are growing in popularity. There are approximately 20.2 million personal loan borrowers in the United States according to the Lending Tree online loan marketplace. You can take out a personal loan for almost anything, from renovating your kitchen, paying for a wedding, going on a dream vacation, or paying off credit card debt.
Most people get personal debt consolidation loans, and because personal loans tend to have a lower APR than credit cards, borrowers can often save money on interest.
What to know before taking out a loan
Before taking out a personal loan, whether secured or unsecured, make sure you have a clear repayment plan.
As a rule of thumb, only borrow what you know you need and can afford to pay off. Make sure you are comfortable with the repayment term. Just because you can get a loan doesn’t mean you should, so take your time and do your research before signing on the dotted line.
Learn more: 10 questions to ask yourself before taking out a personal loan
Information about the Capital OneÂ® Secured MastercardÂ® and the First TechÂ® Federal Credit Union Platinum Secured MastercardÂ® was independently collected by CNBC and was not reviewed or provided by the issuer prior to publication.
Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.