It’s the middle of the summer and your refrigerator breaks. Or, you’re driving home and your car’s engine light pops on. Regardless of the situation, emergencies can pop up at the worst of times. And if you don’t have a large emergency fund tucked away, you could be left scrambling to cover the cost.
Taking out a personal loan can help you pay for necessary repairs or major purchases. If you’re thinking of applying for a loan, you may have come across the terms “unsecured” and “secured.” But what’s the difference?
Below, find out how unsecured and secured personal loans work and which is best for you.
What is a secured loan?
Loans can be secured or unsecured. A secured loan is backed by collateral — property that you own that guarantees the loan. If you don’t pay back the loan, the lender can put a lien on your collateral as payment.
The lien remains active until you repay the loan in full. Then, the lender lifts the lien and has no further claim on your property. However, if you fail to make payments, the lender can seize the item you put up as collateral and sell it to recoup their costs.
Although secured loans pose some risks — you could lose your collateral if you fall behind on your payments — they do have some benefits:
- Lower interest rates: Because they’re guaranteed by collateral, secured loans pose less risk to lenders than unsecured loans. That means lenders can issue secured loans with lower interest rates than they can offer with unsecured loans.
- Easier qualification requirements: Secured loans tend to have less stringent requirements than unsecured loans, so you’re more likely to qualify for a secured loan, even if you have less-than-stellar credit.
- Higher amounts: Because secured loans are often backed by high-value items like real estate, you can qualify for a much larger loan than you could get with an unsecured loan.
What is an unsecured loan?
Personal loans are typically unsecured forms of debt. Unsecured loans don’t require any form of collateral. Instead, lenders review your application and run a credit check to determine your creditworthiness. They’ll determine if you make enough money to afford the loan payments and decide how likely you are to repay the loan on time.
You can get a personal loan from banks, credit unions, or online lenders. Each lender will have their own requirements, but in general, you’ll qualify for low interest rates if you have good credit and a stable income.
Because unsecured loans aren’t backed by collateral, there’s no risk of losing your property. However, there are some downsides to consider. Unsecured loans are riskier for lenders, so they tend to charge higher interest rates than you’d get with a secured loan. If your credit isn’t great, you may have trouble getting approved for a loan on your own, and you may need a co-signer.
Which loan type is best for you?
If you’re trying to decide between a secured and unsecured loan, it’s important to keep your needs and financial goals in mind.
If you need to borrow a lot of money, want the lowest interest rate possible, or have less-than-great credit, a secured loan may make sense. By putting up property as collateral, you can borrow thousands of dollars and qualify for a low rate even with a lower credit score.
If you need a smaller amount — $100,000 or less — need access to the money fast, and have good credit, an unsecured loan can be a smart choice. You can get your money in as little as two business days and score a low interest rate. And, there’s no risk of losing your property, so you can have greater peace of mind.
Applying for a loan
If you need to take out a new loan to pay for an unexpected repair, finance a major purchase, or to consolidate debt, think carefully before applying for an unsecured or secured loan. Weigh the pros and cons of each option to ensure you pick the best loan type for you.
If you decide to move forward with an unsecured loan, make sure you compare offers from multiple personal loan lenders.
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