A loan is a method of borrowing the money that one will repay later, generally with interest. All loans, regardless of their purpose, are either secured or unsecured. There are advantages and disadvantages to considering a secured loan over an unsecured loan. Understanding the distinction between the two is a critical step toward acquiring financial literacy, which can have long-term consequences for financial health.
Secured Loan vs Unsecured Loan
The main difference between a secured loan and an unsecured loan is that in a secured loan the balance is determined by the value of the underlying collateral, whereas in an unsecured loan, it is determined by the debtor’s earnings and reimbursement potential. Another distinction is that a secured loan can be obtained with a poor credit score, whereas an unsecured loan requires a high credit score.
A secured loan is one in which the provider grants a loan to you in consideration for collateral or safety. It might be a tangible item such as gold, a home, or a vehicle, or a financial asset such as stock options, fixed deposit accounts, mutual funds, insurance policies, and so on. Until the loan is repaid, the lender retains the security either physically or as a claim on the ownership.
An unsecured loan is one that does not require you to put up any security. These loans are granted entirely based on your credit history and credit score. While sanctioning the loan, lenders consider your prior repayment history, a consistent form of income, payslips for the last 6 months, among many other considerations.
Comparison Table Between Secured Loan and Unsecured Loan
| Parameters of Comparison | Secured Loan | Unsecured Loan |
| Meaning | A secured loan is guaranteed by an asset or collateral | An unsecured loan is not guaranteed by any asset or collateral |
| Advantages | Higher borrowing limits extended payment terms | Less volatile, reduced borrowing limitations |
| Tenure | Tenure of 15- 30 years | Up to 5 years |
| Interest rate | Lower interest rate | Higher interest rate |
| Processing | Processing is slow and takes time | It has faster processing |
| Example | Mortgage, home equity loan, auto loan | Personal lines of credit, and school loans |
What is a Secured Loan?
A secured loan, as the name indicates, is secured by something that may be used as payment if the default occurs. This alternative is known as “collateral.” Collateral can be your home, vehicle, or other valuable items, the value of which can pay the debt you have acquired.
When a loan is too large, banks will normally want collateral. Because defaulting borrowers are unavoidable, banks utilize collateral to pay the loan balance. For instance, if a property is being used as collateral and the debtor is unable to repay the loan, the bank reserves the right to seize and sell the property. Once the foreclosure process has begun, the borrower must relinquish possession of the property.
Secured loans are the foundation of the housing and car industries. Few individuals would be able to pay real estate prices if house mortgages were not available. Most people would balk at new automobile pricing since they rarely retain huge financial reserves in their savings accounts.
Secured loans make large purchases more affordable. Even better, the power to confiscate the thing being acquired if the loan defaults make these loans appealing to lenders. Security reduces the lender’s risk and helps to keep interest rates low.
What is an Unsecured Loan?
An unsecured loan is one that does not require collateral. It’s “unsecured,” as the name implies, which implies the lending institution has no assets to foreclose on if the borrower fails to pay. Unsecured loans are useful for persons who do not own property or who do not wish to commit their assets. It’s also a wonderful alternative for people who need money right now.
Unsecured loans are appealing to borrowers since no collateral is required to get a loan. This implies that whether you own a home or not, you may apply for a loan as long as you qualify and have all of the required documentation. Unsecured loans are also advantageous to people with great credit ratings and clean credit history. Credit ratings are frequently adequate to qualify you for unsecured loans.
You may buy products now using credit cards as long as you reimburse the card company when you get a statement. If you do not pay the whole balance when the payment is due, substantial interest charges apply, making it exceedingly expensive for the cardholder. Student loans that default appear on a customer’s credit record until the person starts regular payments.
Unsecured loans lack collateral, which is a significant disadvantage for lenders. The inability to collect an asset if a debt falls into default puts lenders’ money at risk, and millions of unsecured loan debtors demonstrate this every day.
Main Differences Between Secured Loan and Unsecured Loan
- A secured loan is one that is guaranteed by an asset or collateral that is promised to the lender, whereas an unsecured loan is one that is not guaranteed by any asset or collateral.
- Secured loans have higher borrowing limits, extended payment terms, and accessible tax deductions for interest charged on certain loans, whereas unsecured loans are less volatile for the borrower, beneficial if one doesn’t own estate to be used as collateral.
- A secured loan has a duration of 15 to 30 years, whereas an unsecured loan has a tenure of up to 5 years.
- A secured loan is said to have a lower interest rate meanwhile an unsecured loan has a higher interest.
- Secured loan processing may take time because collateral must be appraised, but unsecured loan processing is faster since collateral is not valued.
- Mortgage, home equity loan, auto loan, and loan against fixed deposits are instances of secured loans, whereas credit cards, personal lines of credit, and school loans are examples of unsecured loans.
Conclusion
Both secured and unsecured loans offer advantages, and you may choose which is best for you based on your specific position and needs.
A secured loan, for example, would be an excellent alternative if one requires a high loan amount and prefers a longer repayment period in order to handle EMI payments without experiencing financial hardship.
An unsecured loan, on the other hand, would be the ideal option if one is in immediate need of funds (just under a week) and wants to expedite the procedure.
Although, aside from being easier to get, a secured loan contract is generally more attractive to the client than an unsecured loan. Repayment periods are frequently much longer, interest rates are lower, and borrowing limits are larger. All these reasons indicate that a secured loan is more desirable for a borrower.
References
- https://onlinelibrary.wiley.com/doi/abs/10.1111/1468-5957.00192
- https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2822345