Secured vs. Unsecured Personal Loans: How Collateral Changes the Risk
A secured loan is one in which property is pledged as collateral, and the lender maintains a security interest in the property. An unsecured loan is one that does not require collateral. The main difference is how collateral changes the lender’s risk. Unsecured loans may carry higher interest rates, but pricing and qualification depend on the lender, borrower, loan terms, and applicable law. Once a loan is in default, lenders may have different remedies for secured and unsecured debt. Collateral may affect eligibility, but a secured loan is not always cheaper.
Personal loans can take either form. The comparison depends on the particular offers, the total cost of borrowing, and how losing the pledged asset would affect you.
Key takeaways
- A secured personal loan requires collateral. An unsecured personal loan does not require collateral.
- While collateral may lower the lender’s risk, it does not guarantee approval or a lower interest rate.
- A default on a secured loan can result in the loss of the collateral and, depending on the agreement and applicable law, an obligation to pay a remaining balance.
- A default on an unsecured loan may result in credit reporting, collection attempts, and, in some instances, a lawsuit.
- Always evaluate the APR, finance charge, fees, term of the loan, total of payments, and monthly payments not on a stand-alone basis, but in the context of the total situation.
What secured and unsecured mean
Collateralized personal loans typically require the borrower to pledge an asset that the lender may be able to seize if the borrower defaults, subject to the agreement and applicable law. Some lenders take a savings account or certificate of deposit or a personal vehicle. Some personal loans may allow the borrower to pledge other items. The loan agreement will describe the pledged asset and the lender’s right to the asset if the borrower defaults.
If the borrower defaults, the lender may be able to seize and sell the collateral, subject to the agreement and applicable law. If the sale proceeds do not cover the debt and permitted expenses, the borrower may still owe a balance. The Federal Deposit Insurance Corporation describes the collateral risk and the possibility of a remaining debt balance in its consumer guidance.
Personal loans that are unsecured do not require collateral. The loan terms and approval are based on the lender’s assessment of the borrower’s risk of not repaying the loan. A personal loan without collateral does not necessarily have less restrictive terms. The debt will still be legally binding, and the lender or collector may pursue remedies allowed by the agreement and applicable law.
Many personal installment loans are closed-end loans. The borrower receives a lump sum and agrees to a series of installments to repay the loan. The interest rate may be fixed or variable. It is the responsibility of the borrower to confirm the type of interest rate and whether the payment amount is subject to change.
Side-by-side comparison
| Feature | Secured personal loan | Unsecured personal loan |
|---|---|---|
| Collateral | A lender-approved asset is pledged. | No specific asset is pledged. |
| Underwriting | Assessment of credit, income, debts, collateral, and elements of loan offer. | This may include credit, income, debts, requested amount, term, and other information permitted by law. |
| Pricing | Collateral may improve terms, but the APR and fees are lender- and borrower-specific. | Pricing may reflect the lender’s exposure without collateral and the applicant’s risk profile. |
| Main default risk | The primary risks include loss of the collateral, a possible remaining balance, collection activity, and credit damage. | Collection activity, potential legal action, and credit damage may occur even though no specific asset was pledged. |
| Availability | This depends on whether the lender does secured loans and whether they will accept the proposed collateral. | This depends on the lender’s eligibility and how they view your loan request. |
How collateral can affect approval and pricing
Collateral may reduce the potential loss because the lender may be able to recover part of the balance from the collateral. That can influence an offer, but it does not replace underwriting. According to the CFPB, personal installment loan terms may reflect the credit report and score, the applicant’s income, debts, amount, term, state-law limits, and sometimes bank-account activity.
A secured lender may require a valuation, insurance, proof of ownership, or confirmation that another creditor does not have a superior claim on the asset. Ask how the lender determines the value of the collateral, and if the value decreases, will the terms of the agreement change? These requirements differ from lender to lender and asset to asset.
Do not assume that including collateral will resolve issues related to weak credit, result in approval, or ensure the best deal. Look at what you would get under a secured and unsecured loan, given the same requested amount and similar terms.
The cost of credit includes more than the scheduled payment. With longer credit terms, the payment may be lower while the total interest increases, so check offers side by side for the same amount with similar credit terms. In secured credit, the collateral can introduce expenses and conditions that are not in an unsecured credit offer.
For closed-end consumer credit covered by the Truth in Lending Act, regulations require disclosures of the amount financed, finance charge, APR, payment schedule, and total of payments. The APR is designed to express covered credit costs as an annual rate. However, borrowers should still review the agreement to ensure they understand the costs and conditions of the credit. The CFPB notes that personal installment loans can include origination, documentation, optional insurance, non-filing insurance for secured credit, and late fees.
Along with these disclosures, you should also check:
- Valuation and lien costs. Ask about appraisal, title, filing, or non-filing-insurance charges and whether these costs are considered part of the APR or are deducted from the proceeds.
- Insurance and maintenance. Confirm if there is an obligation to insure and maintain the asset and what would happen if the coverage is not maintained and the asset loses value.
- Release of the lien. Learn the processing time for the lender to release its claim on the asset after the final payment is processed and whether fees for early payoff apply.
- Repossession and deficiency terms. Understand the lender’s right to repossess the asset, the order of the sale proceeds application, certain costs the lender may charge, and whether a balance may remain.
When each structure may fit
When considering a secured loan, it is important to note whether the collateral is integral to daily life. A secured loan may be worth considering when the secured offer has a meaningful cost advantage after all fees are taken into account and the payment fits comfortably in the budget. On the other hand, it may be a bad trade to pursue when the pledged asset is needed for work, housing, or other emergency use, or when the rate savings are of little value.
When asset protection is more important than a possible pricing difference, an unsecured loan may be preferable. Again, avoiding a pledge of collateral does not make an unsecured loan safe. High payments can strain the budget and missed payments can lead to collection activity.
There is no good reason to pursue an option only because it appears to be more straightforward. Pricing, funding, collateral requirements, and repayment assistance are lender-dependent. Consider how the offers compare. Does the total cost fit both the amount and time required? Does the payment leave room for necessary expenses? Finally, consider if losing the collateral will disrupt work, housing, transportation, and finances. If neither of the offers meets these guidelines, it may be safer to delay the expense and/or consider a non-loan alternative.
Special care with debt consolidation
A consolidation loan can replace several debts with a single payment, but it doesn’t decrease debt. Evaluate with due diligence the costs and repayment amount for each debt versus the principal, fees, and overall cost to repay the consolidation loan.
As warned by the CFPB, a lower consolidation payment may be spread over a longer repayment period, increasing the total cost of the debt. Additionally, converting card debt from unsecured to secured debt can put an important asset at risk when that asset is pledged as collateral. A good plan accounts for why debts were incurred, and balances are high, and avoids incurring additional card debt as a result of consolidating existing debt.
What happens if you cannot pay
Notify the lender immediately. Each lender has their own policies on due dates for payments; asking for a payment deferral/plan; and interest, fees, credit reporting, and the date when you’ll pay off the loan. These policies will vary.
A missed loan payment may result in fees and collection activity. This may also result in damaged credit for the borrower. For secured loans, the lender may also have the right to take and sell the collateral. If the sale proceeds do not cover the debt and permitted expenses, a deficiency balance may remain. These rights depend on the agreement and applicable state law.
Before pledging an asset online
When filling out a secured loan application that is requesting additional supporting documentation, be prepared to upload ownership documents, account statements, vehicle information, insurance documents, identify income, and potentially other supporting documents. Ensure you have verified the lender’s authority to operate in your state through the relevant state regulator and read their privacy policy to understand how they might use and share the information you are providing.
- Make sure the pledge agreement states the collateral, the lender’s lien rights, and the terms and conditions for releasing the lien.
- Send supporting title, account, and insurance records only after you have verified the lender contact information.
- Do not provide any payment for the promise of approval. The Federal Trade Commission identifies advance-payment demands tied to guaranteed credit as a loan-scam warning sign.
Frequently asked questions
Do secured personal loans always have lower APRs?
Having collateral does not automatically mean that a secured loan charge will be less. Terms and conditions for a loan depend on the borrower as well as the amount and duration of the loan and the risks taken by the lender as well as applicable laws.
Is an unsecured loan safer?
Having no collateral means that there is no claim to a specific asset, but a debt is still incurred. Missing loan payments may result in fees, legal action, collection, and damage to credit.
Can a lender take collateral without canceling the full debt?
If collateral is sold for less than the outstanding balance and permitted expenses, a deficiency may remain, depending on the agreement and applicable state law. Ask the lender to explain this possibility in writing before accepting the loan.
Which assets can secure a personal loan?
The collateral assets will differ. Some lenders will consider a savings account or certificate of deposit; other lenders may consider a vehicle or other asset. Check the valuation, insurance, lien and release, and other terms of the agreement.
Does bad credit make a secured loan the better choice?
A secured loan is not necessarily the best option. Although a secured loan does rely on collateral, the lender may still consider your credit, income, debts, and affordability. The actual cost, the risk of losing the collateral, and your ability to pay should drive the decision. It is not solely based on your credit rating.