What is the difference between secured and unsecured debt?

Key takeaways

  • A secured loan requires an asset as security or collateral, whereas an unsecured loan doesn’t require this.

  • Unsecured loans are riskier for the credit provider and have higher interest rates.

  • You risk losing the asset if you default on a secured loan.

  • Your credit score, reason for borrowing and how much you want to borrow are all factors to consider when you choose between secured and unsecured debt.

  • If you default on either of these types of debt, your credit score can be negatively affected.

 

The main difference between secured and unsecured debt is that secured debt requires an asset as security or collateral, whereas unsecured debts do not. For secured debt, an asset such as a car or property is the collateral for the loan.

How does this impact me?

An unsecured loan is riskier for a lender compared to a secured loan, so they will charge a higher interest rate compared to a secured loan.

YOUR CREDIT SCORE COUNTS

The lower your credit score, the higher the interest rate you will pay, regardless of whether the loan is secured or unsecured.

It may be more difficult to obtain an unsecured loan, as the creditor only considers your credit score, your ability to afford the loan and financial history. A secured loan has an asset that can be sold if you default on your repayments, so this type of loan may be easier to obtain if you can afford the repayments.

In either instance, if you default, you are liable for debt collection costs and fees, and your credit score may be negatively affected.

 

Which loans are secured and which are unsecured?

Here is a list of different loans and whether they are classified as secured or unsecured.

HOW LOANS ARE CLASSIFIED
Secured loans Unsecured loans

Vehicle finance
Credit card
Home loan
Student loan 

Business financing  

Personal loan

Secured personal loan

Payday loan

Policy loan

Debt consolidation loan
 
Revolving credit loan


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How do the repayment terms differ?

The repayment term for secured loans is generally longer, as is the case with home loans, business finance or vehicle finance.

However, a student loan, which is unsecured, may also have a longer term, so there are no hard-and-fast rules when it comes to repayment terms.

 

Which is better: a secured or unsecured loan?

Each type of loan has advantages and disadvantages. You need to examine these before deciding which option is best for you.

Secured loans

On the plus side, this type of credit is easier to apply for, and a creditor may offer you a larger amount of credit, as there is less risk for the provider if you default on the loan. You might also pay a lower interest rate. Just make sure not to overextend yourself simply because more credit is available.

SECURED LOAN COLLATERAL

A secured loan’s collateral does not have to be the asset being purchased. It can be any item of value, such as jewelry or an insurance policy with a surrender value.

The risk is that if you default, the asset you have provided as security may be repossessed and sold. If it is vehicle finance, for example, you may lose your vehicle and have no means of transport. You will also be liable for any legal costs and will have to pay in if there is a shortfall when the creditor sells the asset to recoup their loss. Your credit score can also be negatively affected.


Unsecured loans

The primary benefit is that you don’t risk losing an asset if you default on the loan. However, if you default on your repayments, you will be responsible for legal costs and collection fees, and your credit report will be negatively affected.

On the downside, the debt-to-income ratio requirements are stricter, so you may not be eligible for as much credit as you need.

 

Which form of credit is easier to get?

A creditor evaluates your application based on your credit score, your income and your ability to afford the loan. The amount you earn and your ability to repay the debt are important considerations.

Your credit score shows how well you manage your debt. Some loans, such as personal loans or short-term loans, require a lower credit score, so they are easier to obtain. Larger loans, such as a home loan or business finance, may require a higher credit score and are more difficult to obtain.

Your earnings are also important, and if you’re a lower-income earner, payday loans may be more accessible, as these have easier income requirements.

 

What type of loan is best for me?

This depends on a number of factors:

  • Why you want to borrow money: You may have a personal emergency, or you may want to buy an item, such as an appliance or furniture, without using it as collateral. You may even want to do some minor repairs or renovations to your home and pay the debt back in a short period of time, as opposed to borrowing more against your home in a loan with a long term of ten or more years.

  • Your credit score: If your credit score is low, then a secured loan may be easier to obtain. It is more affordable and a good way to build your credit score if you manage the debt correctly.

  • How much you want to borrow: If you want to borrow a substantial amount of money, a secured loan may be a better option because you will pay a lower interest rate, saving you money in the long run.

TIP FOR BORROWERS

Before applying for any debt, make sure you compare the available options and understand how they best suit your needs. Don’t make a decision based on advertising or other persuasive activities.