There are two primary types of loans: secured and unsecured. But what are the differences? It’s important to understand how each affects you as the borrower.
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Key points
- Secured debts will require you to put up collateral to secure the loan. Car loans and mortgage loans are common examples.
- Because secured loans are backed by collateral, the risk for the lender is low and the risk for the borrower is higher.
- Unsecured debt is not backed by collateral. They are issued based on a borrower’s creditworthiness. Credit card debt and student loans are the most common types of unsecured debt.
- Payday loans are unsecured debt.
- Unsecured loans have a lower risk for borrowers and a higher risk for lenders.
- Because the lender faces more risk with unsecured loans, they usually have higher interest rates.
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At a Glance: Secured Debt vs. Unsecured Debt
| Secured debt | Unsecured debt | |
|---|---|---|
| Collateral required? | Yes | No |
| Repayment term | Fixed, can be as long as 30 years | Fixed or variable, depending on the type of loan |
| Interest rates | Higher; to qualify for reasonable interest rates, you’ll need a credit score of 670 or higher | Usually higher unless you have exceptional credit |
| Credit score requirement | More lenient; the minimum credit score for some FHA home loans is 500 | Higher; to qualify for good interest rates, you’ll need a credit score of 670 or higher |
| Borrower risk | Higher | Lower |
| What happens if you default? | Your asset could be seized | Debt collectors will call and you may end up in court |
| Common examples | Mortgages Auto loans Secured credit cards | Credit cards Payday loans Personal loans Medical bills Student loans |
The key difference between secured and unsecured debt is whether the lender requires collateral.
But What’s Collateral?
The Cambridge English Dictionary provides the following definition:
Valuable property owned by someone who wants to borrow money, that they agree will become the property of the company or person who lends the money if the debt is not paid back.
Pro tip: The other primary difference is what happens if you fail to make your payments as scheduled. If you have a secured loan, your asset may be seized. If you have an unsecured loan, you will face debt collection efforts and may end up in court.
How Unsecured Debt Works
Unsecured loans do not require collateral. If you default on an unsecured loan, the lender’s options to get it’s money back are more limited. They must initiate debt collection efforts or potentially take you to court to request a wage garnishment. The debt may even be charged off as bad debt, hurting your credit score significantly.
Unsecured loan approval is based on your creditworthiness.
Pro tip: A single late or missed payment will stay on your credit report for seven years. In order to ensure that you qualify for the best loans in the future, make at least the minimum payment each month.
The credit score requirements for an unsecured loan are usually higher than the minimum needed for a secured loan. You will likely need a credit score of 670 (good credit) or higher to qualify for the best unsecured loans.
Pro tip: There are unsecured personal loans geared toward borrowers with poor credit, so don’t be discouraged if your credit score is below 670. Some lenders even have no minimum credit score requirement.
READ MORE: How to get a loan with bad credit
The most common examples of unsecured debt include:
- Payday loans
- Credit card balances
- Medical bills
- Personal loans
- Student loans
- Debt consolidation loans
- Credit card balance transfers
If you fail to repay unsecured debt, lenders won’t be able to seize your belongings. However, debt collectors will call and you may face legal action.
READ MORE: How to deal with debt collectors
How Secured Debt Works
Secured debts require borrowers to use an asset as collateral to “secure” their loan.
This means that if the borrower stops making payments and defaults on the loan, lenders will seize the asset to collect the money. This means your home could face foreclosure or your car could be repossessed.
The most common examples of secured debt include:
- Home loans
- Conventional mobile home loans
- Auto loans
- Secured credit cards
- Home equity loans
- Home equity lines of credit
READ MORE: What is a second mortgage and how does it work?
A lien is placed on the asset you use as collateral with secured loans. When you’ve made all of your loan payments, the issuer removes the lien. At this point, you will own the asset free and clear. Loan terms are fixed, so you know exactly when you will own your asset outright.
Pro tip: This is why you won’t receive a car title in your name until your car loan has been paid off. It also means that when you purchase a home, lenders will require proof of homeowner’s insurance, and your lender may be included in insurance claims. The lender has a vested interest in ensuring that if your home is damaged, the necessary repairs are made.
If your credit isn’t ideal, you can also use collateral to secure some personal loans.
This may help you avoid paying a high interest rate for a so-called “bad credit loan.”
Pro tip: You won’t face foreclosure over a single missed mortgage payment, but if you’re facing a temporary hardship, don’t just skip paying. Contact your lender and explain. It’s better to tell your lender that you’re struggling than to simply stop making payments on secured debts.
Here are some examples of assets that can be used to secure loans:
- Real estate
- Vehicles
- Stocks or other investments
- Bank accounts
- Life insurance policies
- High-end heirlooms and collectibles
Because collateral lowers the risk for lenders, credit score requirements are usually more lenient.
Pro tip: You can usually qualify for a mortgage with a credit score of 620. Some government-insured FHA lenders set the cutoff at 500.
However, as with unsecured loans, borrowers with lower credit scores will pay higher interest rates.
What is a Secured Credit Card?
Most credit cards are unsecured with a revolving line of credit and a preset credit limit. However, lenders also issue secured credit cards. These are geared toward applicants with poor credit scores or no credit history.
Pro tip: Secured credit cards can be a good way to establish or rebuild credit, and after a pattern of responsible use has been established, they can be converted to unsecured credit cards.
A secured credit card requires cardholders to deposit a lump sum of money with the lender. That security deposit becomes the card’s credit limit. If you exceed that amount, your charges will automatically be declined.
With a secured card, the cardholder deposits money with the bank. The deposited money becomes the card’s credit limit. Secured credit cards are often used by people with poor credit records or no credit history in order to establish credit and eventually qualify for a regular, unsecured card.
Pro tip: Approval for secured credit cards is not guaranteed. Even though you agree to pay a security deposit, borrowers with poor credit scores may still have applications denied. If that happens, take some time to rebuild your credit score. Sign up for a free service like Experian Boost and use your regular expenses to build credit, and consider using a credit-builder loan. We recommend credit-builder loans from Chime and Self.
Can You Get a Secured Credit Card at Any Bank?
Not all banks issue secured credit cards. You won’t be able to get secured credit cards from the following banks: American Express, Barclay’s, Chase, Synchrony Bank and Wells Fargo.
Banks that offer them include Bank of America, Capital One, Chase, Citibank, PNC, Truist, USAA and U.S. Bank. Many smaller banks and credit unions also offer secured credit cards.
READ MORE: Best secured credit cards
Secured or Unsecured Debt: Which is Better?
Secured debt has lower interest rates and more lenient credit history requirements. However, the risk if you stop making monthly payments and fail to repay your loan is significantly higher because you could lose your home or transportation.
Unsecured debt has higher interest rates and more stringent credit history requirements, but if you can’t repay the loan, the stakes will be lower because the lender has no assets to seize.
Pro tip: You may not have a choice when it comes to the type of debt you’re getting. Secured debt will likely be your only option if you’re financing a home or car.
In general, unsecured debt offers more flexibility and less risk for borrowers.
READ MORE: Free (or cheap) tricks to pay off your credit cards
The Bottom Line
Before you complete a loan application, it’s essential to know whether the loan is secured or unsecured and what the differences mean.
The best choice will depend on what you’re buying, your credit history and the amount of risk you’re willing to take.
FAQs
Both. Though most personal loans are unsecured, some financial institutions will allow you to use personal assets to secure your loan application. This is particularly useful if your credit score is on the lower end but you have family heirlooms with value. Using them as collateral allows you to borrow money without being forced to sell items that may have sentimental value.
Payday loans are typically considered unsecured loans. Payday loans don’t require collateral.
However, because eligibility is simple, the loan rates charged by payday lenders are exceptionally high. Because of this, some states have outlawed payday loans, while others have imposed heavy restrictions on payday lenders. It’s best that you avoid payday loans as much as possible because they will almost always make your financial situation worse instead of better.
A secured credit card requires the cardholder to make a down payment in order to secure the account. So a $250 secured credit card would require a $250 security deposit, which will be held as collateral, and your credit limit would be $250.