Consumers who need to borrow money have a wide range of loan options to consider. However, all loans, lines of credit and other methods of financing fall into one of two categories: unsecured or secured debt.
While both secured and unsecured loans and lines of credit can help you achieve your goals, there is one main factor that sets them apart. Where secured loans require collateral, unsecured financing methods do not require any collateral.
Unsecured loans vs secured loans
What is an unsecured loan?
Unsecured loans and financial products can come in many different forms, but the underlying principle and agreement is the same. Consumers don’t have to deposit their assets to get an unsecured loan, but they have to agree to repay the money they borrow – plus interest, of course.
Without any collateral requirement at the start of the loan, it shouldn’t surprise you that unsecured debt has more stringent requirements to qualify. You usually need good or excellent credit to qualify for unsecured loans with the best interest rates and loan terms. You should also be able to demonstrate your repayment capacity and prove that you have a reasonable liability for your income.
Unsecured debt can take many forms, the most common being:
- Unsecured credit cards (the vast majority of credit cards)
- Most personal loans
- Student loans
Other debts considered unsecured include telephone and utility bills (and other utilities), court judgments, gym memberships, and even medical bills. Unsecured debt is any type of debt that is not secured by an asset.
Benefits of unsecured loans and lines of credit:
- When you apply for an unsecured loan or a credit card, you will not have to put down a cash deposit as collateral.
- If you default on unsecured debt, the bank will not be able to seize your assets.
- The application process is generally quick and painless. You can apply for personal loans and unsecured credit cards online and from the comfort of your own home.
Cons of Unsecured Loans and Lines of Credit:
- While the bank can’t foreclose your assets if you default on unsecured debt, they can try to get a judgment against you. Failure to repay your loan will also cause serious damage to your credit score which can be difficult to overcome.
- The conditions for approval are more stringent. You need good or excellent credit (usually a FICO score of 740+) and a solid professional background to qualify for unsecured loans and credit cards with the best interest rates, conditions and advantages. You may qualify for some unsecured loans with fair credit, but you will usually pay a higher interest rate and higher fees.
- Interest rates tend to be higher on unsecured debt as compared to certain types of secured debt.
What is a secured loan?
Secured debt is any type of debt held with some form of collateral underlying. It could be a cash deposit you put down, an automobile, your house, stocks you own, or any other asset of significant value.
Although consumers with secured debt agree to a repayment plan, the asset they used as collateral is at stake. If they default on their secured line of credit or secured loan, their collateral will be foreclosed on. result.
Secured debts are generally considered to be less risky for the lender because they have an asset to foreclose in the event the borrower stops making payments. For this reason, secured debts often have lower interest rates than unsecured alternatives.
Secured loans and lines of credit can work very differently depending on the type of secured debt you are dealing with. The most common types include:
- Secured credit cards
- Guaranteed personal loans
- Home equity loans
- Home Equity Lines of Credit (HELOC)
- Auto loans
While it makes sense for you to use your home as collateral for a mortgage or home equity loan and a car as collateral for a car loan, you might be wondering why someone would borrow money if they wanted to. he is required to post a security. This is especially true when it comes to secured credit cards, as they require you to deposit a cash deposit that is usually equal to your credit limit (for example, you deposit $ 500 to receive a credit limit of $ 500).
There are many reasons people apply for credit cards and secured loans, including the fact that the credit requirements are not so strict. For people with bad credit, secured credit cards may be the only type of card they can qualify for. And, if you can’t get approved for a credit card or unsecured loan, going with a secured option may be a good idea as it can help you build your credit score over time.
For example, the Capital One Secured Mastercard is available to consumers with limited credit history and low credit scores who can deposit up to $ 200 to receive a $ 200 line of credit. While this limit is probably lower than most people want, this card reports your credit movements to the three credit reporting agencies – Experian, Equifax, and TransUnion. You will also be able to get a higher credit limit after making five monthly payments on time. In addition, there is no annual fee.
With the Capital One Secured Mastercard, a consumer would be able to accumulate credit when he could not otherwise. So while putting down a cash deposit isn’t ideal, it’s a smart decision in the long run.
Benefits of secured loans and lines of credit:
- You might qualify with bad credit or a limited credit history.
- Many secured loan options (HELOC, home equity loans, mortgages, and auto loans) come with low interest rates and fair terms because they are backed by collateral.
- Placing security can allow you to borrow more money than you could otherwise get.
- Secured loans can help you develop your credit.
Cons of secured loans and lines of credit:
- Secured credit cards tend to come with high interest rates and fees.
- If you default on a secured loan, your assets will be foreclosed. Failure to pay off a mortgage, home equity loan, or HELOC will ultimately result in foreclosure, and failure to pay off your car loan will result in repossession of your car.
- Many unsecured loan options, such as mortgages and home equity loans, require a tedious application process.
- As with any loan, failure to repay the money you borrow can adversely affect your credit rating and your overall credit health.
The bottom line
Before you borrow money, take a line of credit, or apply for a credit card, make sure you know the difference between secured and unsecured debt. While either can help you achieve your goals, the presence or absence of guarantees is an important consideration that should be decided in advance.
Whatever you do, take the time to compare loan options and read the fine print before signing on the dotted line for any type of loan. If there are any unsavory terms and conditions to be found, they will be hidden in the fine print.
Related coverage of How To Do It All: Money:
How to calculate your credit card interest so you know exactly how much your outstanding balances will cost you
How to choose a student loan to get the money you need for your college or graduate education
How to save money for a house, whether you buy next year or in 5 years
How to create credit with a credit card
How to manage your money according to the experts