The beauty of a personal loan is that in most cases the funds can be used for just about anything you need, from making a larger purchase to paying off bills to consolidating outstanding debt.
This type of loan can be quite appealing since its versatility allows it to be used in a broad range of situations where you may need a quick infusion of cash.
More specifically, a personal loan allows an individual to borrow money from a variety of sources such as a bank, credit union, or online lender in order to cover major expenses such as medical bills or home repair costs.
It can also be used to consolidate high-interest credit card debt. Personal loans typically come in two different forms: secured and unsecured. The major difference between the two is collateral.
In this post, we will be explaining the difference between secured versus unsecured loans and highlighting some of the pros and cons of each. We should mention up front, however, that this is a very high-level overview of personal loan types, and isn’t a substitute for advice.
Everyone’s financial situation is unique, and you should always consult with a professional if you have questions about financial topics like personal loans.
What are Secured Personal Loans?
With a secured loan, the borrower offers something of value, such as their car as backing—also called “collateral”—for the loan. An example of this type of loan is a car title loan.
Other times, lenders may loan out money using the borrower’s savings, investment account or certificate of deposit as collateral. The lender has the right to take ownership of the collateral in the event that the borrower stops making payments.
A lender will usually give the borrower notice that they have defaulted on their loan and allow them the opportunity to become current in their payments before they lay claim on any collateral, however.
Pros of Secured Loans
Given that a secured loan involves collateral, the lender typically views these types of loans as less “risky.” The borrower is less likely to default because it would put the collateral at risk.
And because there is less risk for the lender, they may offer better terms such as a lower interest rate or higher loan amount than they might for unsecured loans. Plus, if you’re in the process of rebuilding credit, a lender may be more willing to loan you money if it’s secured by collateral.
Cons of Secured Loans
The major drawback of a secured loan is that the borrower faces the potential risk of losing their collateral if they are unable to continue paying. Further, a secured loan is typically used to purchase a particular asset, like a car or a home, and the funds usually can’t be used for anything else.
The other major drawback is that the approval process can be more complicated and usually requires more time and paperwork.
What are Unsecured Personal Loans?
With an unsecured loan, a borrower doesn’t have to offer collateral in order to qualify. This type of loan is sometimes called a “signature loan” because after loan approval, the funds are provided with only the borrower’s signature as a commitment to pay back the money.
Because there is no collateral backing up the loan, a lender will rely on the borrower’s creditworthiness (among other personal financial factors that vary from lender to lender) in order to determine whether to approve the loan.
Pros of Unsecured Loans
The approval process for an unsecured loan is typically simpler and faster (but not necessarily easier in terms of getting qualified, since unsecured loans typically require a stronger credit and financial history than secured loans). It also typically requires less paperwork. Additionally, with an unsecured loan, the borrower doesn’t risk losing valuable property in the event of nonpayment.
Cons of Unsecured Loans
Given that an unsecured loan is generally considered riskier for the lender, the loan limits may be smaller. Lenders may also charge a higher interest rate than they would for a secured loan.
While a borrower doesn’t risk losing collateral, the lender still has the right to take steps to collect the debt. Depending upon circumstances, Failure to pay back the loan could have an impact on a borrower’s credit score, and the damage can last for years.
An unsecured loan is riskier for the lender
Both secured and unsecured personal loans can be a great way to help a borrower access funds without having to incur high interest credit card debt. As with any loan, a borrower should carefully evaluate the advantages and risks in order to make an informed decision based on their unique financial situation.
The extra cash a personal loan provides could help a borrower cover an emergency and maybe even achieve some financial goals that may otherwise not have been possible, such as consolidating credit cards or other high-interest debt into better terms, or conducting a major home renovation.
Secured vs Unsecured: Which to Consider
So now that you know the difference between secured and unsecured loans, how can you determine which is the right choice for you?
In general, individuals may have a better chance at qualifying for a secured loan because of the collateral attached to the loan.
Additionally, secured loans could offer better terms in some cases, because the lender has something of value to make them whole in the event of non-payment. Plus, lending limits can be higher on secured loans—if a larger loan amount is most important for your needs.
But, if you have a solid financial profile, you may be able to qualify for an unsecured loan with favorable terms, which you would not have to put up any collateral for. This can be a better route for some people who do not want to risk any of their belongings (like a car) or may not have any collateral to offer.
It’s a good idea to shop around with different lenders to compare interest rates, fees, lending limits, and types of personal loans to see which is the right fit for you. Each of these aspects can vary widely by lender; plus, loan qualification requirements may also vary significantly.
In general, banks and most other lenders prefer personal loan consumers with higher credit scores, as this can be a good indicator of how a person manages their credit. Credit unions may offer a little more wiggle room when it comes to their eligibility requirements, but you’d likely need to be a member to qualify.
Online lenders may have better loan terms if you have decent credit, but you’ll need to make sure that the lender can issue a personal loan in your state. (You can take a look at the states where SoFi currently holds lending licenses here.) And, of course, lenders consider a variety of financial information when evaluating consumers.
Credit Score Insights
Because credit scores typically play a big role in whether or not you can get approved for a personal loan—and what your loan terms would be if you did get approved—it may be helpful to know your credit scores before you apply.
Some people may find that their credit scores give them the freedom to choose between a secured and unsecured personal loan; others may have a score that would ultimately cause a lender to require collateral, while still others may feel the need to improve their scores before they apply in order to obtain the best terms ona personal loan.
Although individual lenders may have differing eligibility requirements when it comes to loan approvals and qualifying credit scores, here is some general information. The majority of lenders, more than 90% in fact, use the FICO® Score to review a borrower’s credit. Using that system, scores can range from 300 to 850 (with some industries using a system from 250 to 900).
A FICO Score that’s below 580 can be perceived as poor, signaling to lenders that you’re a risky borrower. Borrowers with this type of score may have trouble qualifying for loans. A score between 580 and 669 is considered to be “fair.” This ranking is below average, but depending upon the reason for the low score, wouldn’t necessarily prevent some lenders from approving a loan application.
Each lender can have unique guidelines on what’s considered a good score for lending purposes. According to FICO®, a “good” credit score usually falls in between the range of 670 and 739, and this is about the average for consumers in the United States. A “very good” score, according to FICO, falls between 740 and 800, while a score of 800 or above is “exceptional.”
If you are looking to work on your score, here are a few commonly suggested tips from MyFICO that could potentially help.
SoFi Personal Loans
If you are interested in applying for an unsecured personal loan, check out SoFi. SoFi offers low-rate unsecured personal loans with no fees. Yes, that’s right.
No origination fees, no prepayment fees, and no late fees. Whether you have a cross-country move coming up or need help with unexpected medical bills, you can check your personal loan rate in just minutes.
Take a look at SoFi’s personal loan calculator to get an idea of how much interest you could save if you consolidated high-interest loans with a SoFi personal loan.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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