Many a times in life, you need a significant amount of money to fulfil your needs, like buying a vehicle, financing your family vacation, house renovation, or maybe even handling an unexpected medical emergency. Sometimes, you need money to invest in your business or pay for your education. At such times, taking a loan can be a good idea if you don't have sufficient funds.
There are two ways to get the funds, viz., secured loan and unsecured loan. While secured loans require collateral to get the funds, unsecured loans do not. The type of loan you choose can affect your loan terms, interest rate, and eligibility criteria. So, it's worth understanding the difference between the two.
In this blog, we will explain in detail about these loans and find out what is the difference between secured and unsecured loans.
What are secured loans?
Secured loans are a type of borrowing in which you pledge some form of collateral to the lender. A collateral is any valuable asset or property that a lender can seize in case of default. Collateral provides security for the lender and thus results in lower interest rates than unsecured loans.
Types of secured loans
These are some common types of secured loans.
#1. Mortgages
A mortgage, or a home loan, is a loan used to finance the purchase of a home or property. The property itself is collateral, and if the borrower fails to pay the loan, the lender can foreclose on the property to recover the money.
#2. Auto loans
The vehicle acts as collateral when you take out an auto loan to buy a car or a two-wheeler. If you default on the loan, the lender can repossess the vehicle to cover their losses.
#3. Secured credit card
Some lenders issue secured credit cards when the cardholder deposits money with the bank, which acts as the card's credit limit.
#4. Secured personal loans
Some personal loans are secured, meaning they require collateral. This could be your savings bank account, stocks and bonds, gold, or other valuable assets.
#5. Secured business loans
Similar to secured personal loans, businesses can opt for a secured loan for financing their operations, expansion, or other needs.
Often, the value of the collateral determines the amount you can borrow, the loan's terms, and interest rates. Since the risk associated with secured loans is less due to the collateral, you might be able to fetch attractive interest rates and suitable loan terms even with a low credit score.
Secured loans have advantages and disadvantages, and it's essential to consider these factors before deciding to take one.
Advantages of secured loans
#1 Lower interest rates: Secured loans have lower interest rates than unsecured loans because of the collateral.
#2 Highly accessible: Individuals with lower credit scores can also avail of secured loans.
#3 Higher loan amounts: Because of collateral, borrowers can get higher loan amounts than unsecured loans.
#4 Longer Repayment Terms: Secured loans generally have longer repayment terms.
#5 Building Credit: Timely repaying a secured loan helps improve your credit score.
Disadvantages of secured loans:
#1 Risk of collateral loss: The biggest disadvantage of a secured loan is the risk of losing the collateral if you fail to pay the loan.
#2 Few collateral options: Some borrowers might not find suitable collateral for a secured loan if they don't own any valuable assets.
#3 Chances of overborrowing: Since secured loans are eligible for higher loan amounts, borrowers might end up taking more debt than needed, which can impact their affordability and repayment.
What are unsecured loans?
Unsecured loans are a type of borrowing where the borrower does not need to provide any collateral to guarantee repayment. These loans are based on the creditworthiness and repayment capability of the borrowers.
Types of unsecured loans
These are some common types of unsecured loans.
#1. Personal loans
These loans can be used for various purposes, such as debt consolidation, home renovations, medical bills, or other individual needs.
#2. Credit cards
The credit card limit provided to you is a form of unsecured debt.
#3. Student loans
Most student loans are unsecured and rely on the borrower's creditworthiness.
Advantages of unsecured loans
#1 No collateral required: The borrowers do not need to give any assets as collateral; hence, there is no risk of losing any assets in case of default.
#2 Faster processing: They have a quicker approval as there's no collateral to evaluate.
#3 Versatile use: Borrowers can use unsecured loans, such as personal loan, for various purposes, such as debt consolidation, buying an expensive gift for loved ones, travel, or other personal needs.
#4 Helps in build credit score: Paying unsecured loans on time can positively impact the borrower's credit score, contributing to a stronger credit profile.
Disadvantages of unsecured loans
#1 Higher interest rates: Unsecured loans typically carry higher interest rates than secured loans because there's no collateral to provide security for the lenders.
#2 Lower loan amounts: The loan amount available for unsecured loans is usually lower.
#3 Strict eligibility criteria: Lenders might set strict eligibility criteria to qualify borrowers for an unsecured loan. These can include factors such as good credit scores, stable income, and a strong financial history.
#4 Difficult to obtain: Unsecured loans might be more difficult to obtain than secured loans since they carry a certain level of risk for the lender.
What is the difference between secured and unsecured loans?
When we compare secured loans vs unsecured loans, these are the fundamental differences between them.
Criteria
Secured Loan
Unsecured Loan
Collateral Requirement
Required
Not required
Risk for Lender
Low
High
Interest Rate
Low
High
Loan Amount
High
Low
Repayment Terms
Long
Short
Secured vs unsecured loan: Which one to choose?
Secured loan and unsecured loan both have their pros and cons that you must evaluate when you are looking for a loan. A secured loan might make more sense if you're seeking a lower interest rate on loan, while an unsecured loan is a good option for borrowers who don't have a tangible asset to offer.
Tata Capital offers various secured and unsecured loans that you can avail of to fulfil your financial needs. Check them today.
01 August 2023
5 mins read
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