This article was contributed by James Hamory, Research Analyst at LendEDU.
Let’s be honest, applying for loans can be stressful. Sure, nowadays you can fill out an application quickly online to borrow money for just about anything, but then you have to make decisions about what kinds of loans you want. Do you want variable rate loans or fixed rate loans? What term length do you want? Are you willing to pay an origination fee or do you want a no-fee lender?
It can feel like you’re at your favorite coffee shop and faced with the agonizing decision of whether you want Jack or Cheddar on your breakfast sandwich. Can’t you just have both?
But answering these types of questions is actually easier than it seems–if you do a little background research.
One question you’ll surely encounter the next time you’re in the market for a personal loan is whether you want an unsecured or secured personal loan.
Why might you be in the market for a personal loan? You might want to refinance credit card debt, make a big purchase, do some home improvements, or even start your own coffee shop where people can get every kind of cheese they want on their sandwiches.
Not sure whether unsecured or secured personal loans are right for you? Read on!
Unsecured Personal Loans
Unsecured personal loans are loans that are given to you without any of your assets attached as collateral. That means that if you are unable to repay your loan, the lender doesn’t have an asset backing the repayment of the loan. While your credit will suffer and you are legally obligated to repay, they can’t automatically seize your assets because you didn’t have to give up the title on your car or put a lien on your home in order to take out your loan.
So, why would a personal loan company just give you money if they don’t have some guarantee that you’ll repay them?
Lenders decide to trust those who they extend unsecured personal loans to for a variety of reasons. Most lenders look at your credit score and your income. If you have a good credit score, that means that you’ve told other lenders that you’re good for your debt and you’ve actually paid that debt back.
Some lenders, like Earnest, look at additional factors before deciding to lend a borrower an unsecured personal loan like their employment history, savings patterns, investments, education, and growth potential. They then factor in the risk that they’re taking on regarding how likely you are to pay them back and then decide what to charge you in interest.
Secured Personal Loans
In order to take out a secured personal loan, you typically have to secure that loan with one of your assets.
For example, secured personal loans are like going to the pawnbroker, asking for money, and leaving your watch there to secure the loan. It is more common to secure your car (e.g., a title loan) or your home (home equity loan).
If you’re unable to pay, the lender will sell or lien your car or home in order to recoup their costs–just like the pawnbroker would sell your watch.
Why would anyone get a secured personal loan? Lots of reasons! The most common reason is that rates tend to be lower and the borrowing limits higher with secured loans. Also, for people who have a rocky credit history or low income, a secured loan often gives the lender more assurance and helps people in this category get loans.
How Secured and Unsecured Loans Are Similar
At the end of the day, a personal loan is a personal loan. A company lends you money and you pay that company back over a specific term length via monthly payments. The process of paying off a secured or unsecured personal loan is the same.
How are Secured and Unsecured Loans Different
The biggest differences between secured and unsecured personal loans are the costs, the types of borrowers who qualify, the term lengths, and the application process. The APR on secured personal loans is often lower since there is less risk for a lender, however, that’s not always the case since some lenders provide great rates based on other factors like they do at Earnest.
Secured personal loans also allow borrowers with lower credit scores and incomes to qualify for loans and lenders can sometimes borrow more if they opt for a secured personal loan.
But if you’re using a car as security on your personal loan, you might have fewer term-length options since, because of depreciation, many lenders will only accept cars as collateral on personal loans if the vehicle is under five to seven years old.
Finally, there are some extra steps when it comes to the application process on a secured personal loan since you might have to transfer title of your car over to the lender or put a lien on your home. That can take up extra time and might translate into additional application costs or higher origination fees, and a longer wait. If you need money quickly, an unsecured personal loan may be an easier thing to obtain.