There are two different types of loans: secured loans and unsecured loans. Knowing the difference between the two is an important step towards achieving financial literacy that can have a long-term effect on your financial health.
The basic difference between the two is – a secured loan needs the borrower to provide collateral while an unsecured loan does not. This small difference has a huge impact on practically all aspects of the loan – borrowing limit, interest rate and repayment terms. Let’s understand more about these two loan types.
What Is an Unsecured Loan?
As the name suggests, an unsecured loan is not backed by collateral such as gold, home, land, etc. Unsecured loans pose a maximum risk to the lenders, and therefore they are offered at high-interest rates.
Features of Unsecured Loans
- High-interest rates
- Smaller loan amounts
Advantages of Unsecured Loans
- Convenient and easy to meet criteria
- Timely loan repayments help improve your credit score
- Use it as you please – for any purpose
- If you fail to repay your loan, the lender cannot automatically take your assets
Disadvantages of Unsecured Loans
- Because of the high-interest rates on unsecured loans, you end up paying more than you had bargained for
- Shorter repayment schedules
- Missed payments can harm your credit score
Some Examples of Unsecured Loans
Although there are different types of credit cards, a typical credit card bills you once a month and charges interest on the outstanding balance every month.
These loans are flexible and can be used for many purposes, such as education, medical, wedding, mobile phone purchase, travel, etc. The loan amount range can vary from a few thousand to a few lakh depending upon your credit history and repayment capacity.
Personal Lines of Credit
A personal line of credit is similar to a credit card. It has an approved credit limit that you can use as you please. However, it has much lower interest rates than credit cards. Moreover, the interest is applied only on the amount you withdraw from your credit line.
What Is a Secured Loan?
A secured loan is protected by an asset. The loan is given by the financial institution after a valuable asset, such as house, car, land, gold, etc. is used as collateral or security for the loan. A secured loan poses minimal risk to the potential lender.
Features of Secured Loans
- Difficult to qualify for
- High borrowing limits
- Long repayment tenure
Advantages of Secured Loans
- Lower interest rates
- Longer repayment schedules
- Consistent and timely loan repayments can boost your credit score
Disadvantages of Secured loans
- If you can’t repay the secured loan, the lender can sell the collateral to recover the loan money
- If you default on your loan, you can harm your credit score
Some Examples of Secured Loans
This is a loan you take to finance your home purchase. Here, the home is the collateral to get the loan.
A car/auto loan is a loan you take to finance your vehicle purchase. The car or the vehicle is the collateral here.
Loan Against Property (LAP)
You can get this secured loan by mortgaging your residential, commercial, or industrial property. Typically, when you put up your home as collateral, you can get a secured loan at the lowest interest rate.
Using gold as collateral, you can get a secured loan from banks and financial institutions. Banks usually approve a loan amount that is 70-80% of the gold value.
Loan Against Investment Papers
Investments are not made for liquidity, but they are valuable and can be used as collateral to get a secured loan from banks and financial institutions.
Secured loan vs. Unsecured Loan: The Summary of Differences
|Unsecured Loan||Secured Loan|
|Not protected by any collateral||Connected to a piece of collateral like home, car, etc.|
|High risk for lenders||Low risk for lenders|
|If you default on the loan, the lender can’t automatically take your valuable assets||The lender can take possession of the collateral if you don’t repay the loan as agreed|
|Comparatively higher interest rates||Lower interest rates|
|Low borrowing limits||High borrowing limits|
|Easy to qualify for||Difficult to qualify for|
|Examples: Home loans, car loans||Examples: credit cards, personal loans, personal lines of credit|
Secured loan vs. Unsecured loan: Which Is Right for You?
Now that you know the differences between a secured and unsecured loan, you’ll be in a better position to choose the right option depending on your unique needs. But before you make any decision, consider checking your credit report and credit score. Knowing your credit score can help you make an informed borrowing decision.