It’s Monday morning, and you’re rushing to get to work on time. Suddenly, your car starts making a horrible cranking noise. You manage to get it to the shop, but the repair will cost thousands of dollars, and you simply don’t have that much money in the bank. What can you do?
Taking out a loan can be a smart way to pay for an unexpected emergency or to finance a major purchase. If you’re shopping for a loan, you may have come across the terms “secured” and “unsecured.” To make sure you choose the right loan type for you, it’s important to understand what these terms mean and how they differ from one another.
What are secured loans?
With a secured loan, you only qualify for the loan if you put up some form of valuable as collateral. If you can’t repay the loan, the lender can take your collateral and sell it to get its investment back.
Car loans are one of the most common examples of secured loans. When you took out the loan, you signed a legally binding document that says you agree to make payments on time. If you fall behind, the lender can seize your car and sell it at auction to recoup the cost of the vehicle.
Secured loans may sound a bit chancy, but they have their advantages. Because secured loans are backed by collateral, there’s less risk to the lender. That means the lender can often offer you lower interest rates on the loan than you’d get with an unsecured loan, helping you save money. For example, the average interest rate on a new car loan from finance companies is just 4.9%, according to the Federal Reserve. That’s significantly lower than the average interest rate — 10.23% — on unsecured personal loans.
Because the loan is backed by collateral, lenders are usually willing to lend you more money with a secured loan than with an unsecured loan. If you need to borrow a large sum — to buy a car or a house, for example — you’ll likely need a secured loan.
What are unsecured loans?
Unsecured loans work quite differently than secured loans. They don’t require you to use any of your property as collateral. Instead, lenders review your credit profile and income to decide how trustworthy of a borrower you are. If they approve you for a loan, they’ll charge you an interest rate based on the level of risk you present.
Because they don’t have collateral, unsecured loans tend to have higher interest rates than secured loans. And, lenders will be stricter about how much money they’re willing to lend to you.
Student loans are a common form of unsecured loan. As a student, you can borrow money to pay for your tuition and fees, without having to put up your car or home as collateral. Private student loan lenders will base your interest rate on your credit profile.
Most personal loans are also unsecured. You can take out a loan from a bank, credit union, or online lender to finance a major purchase, consolidate debt, or pay for that car repair. Depending on your credit score, you may be able to qualify for a relatively low interest rate, and have several years to repay it.
See also: How Much Personal Loan Can I Get On My Salary?
Keep in mind that missing your payments on an unsecured loan still has consequences. If you fall behind, lenders can send your account to collections or they can even take you to court so they can garnish your wages.
Finding an unsecured loan
Now that you know the difference between secured and unsecured loans, you can make an informed choice about which loan type is right for you.
If you decide to take out an unsecured loan to pay for a major purchase or to consolidate debt, we suggest taking a look at Citizens Bank. We like them for their low interest rates and a quick approval process.