Secured loans vs Unsecured Loans: Know the differences

With an increasing number of financial institutions offering loans to help you fulfill all your needs, it can be confusing to understand which loan you should opt for. One of the key features that can help you make this decision is knowing whether the loan is secured or unsecured.

The type of loan you select will determine the loan amount you can get, the interest rate applicable, the tenure of the loan and most importantly, whether you need to provide collateral to get the loan.

As both loan types have completely different characteristics, it is important for you to understand the basic differences between the two. Choosing the right loan product is the key to your long term financial health.

We have compiled a guide to help you understand everything you need to know about secured and unsecured loans to take a well-informed decision.

Let us first understand what are Secured Loans?

As the term suggests, secured loans are those in which an asset is used as security against the loan amount. The type of asset used as collateral can be stocks, bonds, certificates of deposit or personal property. The loan amount sanctioned is based on the market value of the asset and differs depending on the type of asset. In the event of default, the lender holds the right to sell the asset to recover the dues in full.

Examples of secured loans include home loans, auto loans, gold loans and loan against property (LAP).

What are Unsecured Loans?

Unsecured loans are the opposite of secured loans and do not require any collateral to get a loan. The loans are sanctioned based on the credit score, employment status, income stability and repayment capability of the borrower.

In case, the borrower defaults on the loan, the lender has very few options to recover the dues. And, if it is a case of willful default, the lender can initiate legal proceedings against the borrower to recover their dues.

Some of the examples of unsecured loans are personal loans, education loans and credit cards.

Difference between Secured Loans and Unsecured Loans

While the requirement of collateral is the key difference between secured loans and unsecured loans there are other distinguishing features as well. Some of these are as follows:

Rate of Interest

The lender bears a lower risk of loss since secured loans are backed by collateral. This is why secured loans are available at relatively lesser interest rates.

On the other hand, unsecured loans are considered risky for the lender, who charges a higher interest rate to compensate for the increased risk due to a lack of collateral.

Tenure

Secured loans are suitable for medium to long term borrowing and offer long repayment tenure spanning over 10 years. Such loans are generally taken for buying a house, property or starting a new business.

Unsecured loans have a shorter repayment period that can range from 12 to 60 months and are mostly taken for covering immediate financial requirements. It includes meeting unplanned expenses, paying for medical emergencies or consolidating existing debts.

Ease of Access

Compared to its unsecured counterpart, secured loans are much easier to obtain if the borrower meets the eligibility requirements and has all the requisite paperwork in place.

Unsecured loans, on the other hand, are fasted to obtain but the terms and conditions of the lender are stricter in this case. The lender carries out a detailed verification process of the documents submitted and the credit profile of the borrower before approving the loan.

Risk involved

While the lender may have to bear lower risks while approving a secured loan, the risk is much higher for the borrower. In case of default, the borrower will lose ownership of the assets put up as collateral and also bear the brunt of a negative credit report.

In unsecured loans, both the lender and borrower face a greater level of risk. In case the borrower defaults on the loan, the lender has to write off the loan amount as a loss in his/her books. The borrower runs the risk of negative credit reporting, which can adversely affect his/her chances of getting a loan in the future.

Creditworthiness

Every lender relies on the creditworthiness or the credit score of the borrower before approving the loan amount. It helps them determine the degree of risk involved in such a transaction.

There is a higher chance that your loan application will get rejected based on poor credit history in the case of an unsecured loan. However, in a secured loan, the lender gives lower weight to credit score if you are fully providing for the loan. Availing a secured loan can help you rebuild your credit history while also giving you access to a larger sum of money.  

So what loan should you opt for?

In certain situations, taking a secured loan makes more sense since the interest rates are lower. Since it’s a loan against a collateral, the borrower also gets more favourable term. If you are buying a home or a car, then this makes more sense.

If you want smaller loans and do not want to put your property as collateral, then unsecured loans are the way to go. This is more apt for people looking for smaller amounts of money to finance an immediate credit requirement.  

Conclusion

It is important to understand the difference between secured and unsecured loans to know which is more suitable for your requirements. It will also help you evaluate your eligibility for both types of loan . In many cases, the comparison of secured and unsecured loans is only limited to the rate of interest being offered. But, it is just as necessary to consider all other factors before you decide to apply for a loan.