There are two different types of loans: secured loans and unsecured loans. Understanding the differences between the two is an important step in achieving financial literacy, and can have a long-term effect on your financial health.
Basically, a secured loan requires borrowers to offer collateral, while an unsecured loan does not. This difference affects your interest rate, borrowing limit, and repayment terms.
A secured loan is one that is connected to a piece of collateral – something valuable like a car or a home. With a secured loan, the lender can take possession of the collateral if you don’t repay the loan as you have agreed. A car loan and mortgage are the most common types of secured loan.
Advantages of Secured Loans
- Lower Rates
- Higher Borrowing Limits
- Longer Repayment Terms
Examples of Secured Loans
- Loan against property
- Home equity line of credit
- Car loan
An unsecured loan is not protected by any collateral. If you default on the loan, the lender can’t automatically take your property. The most common types of unsecured loan are credit cards, student loans, and personal loans.
Examples of Unsecured Loans
- Loan against property
- Home equity line of credit
- Car loan
Secured Loan Vs. Unsecured Loan
|Features||Secured Loan||Unsecured Loan|
|Collateral||The loan is secured loan, i.e., it is availed by pledging collateral. The lender uses the asset as security against payment default. For instance, if you take an auto loan and default on your payments, your vehicle could be disposed off by the lender to recover unpaid dues.||Most unsecured loans are personal loans. It is a multi-purpose loan where you are not required to provide any asset as security. Before approving your loan application, banks do a background check on your professional details, your financial health and your credit history to arrive at a lending decision.|
|End use||The end use of the loan amount on a secured loan could be a mix of restricted and flexible. For example, the loan amount for car loans or home loans can be used only to purchase a car or a home, respectively. The car / home is mortgaged with the lender until the loan is repaid back in full. On the other hand, in the case of gold loans or a loan against property, the end use is not restricted to a specific payment.||You could use the loan amount for any purpose – be it for buying furniture or other home improvements, for the perfect holiday, purchase of consumer durables, to fund your children’s education, for your child’s marriage, as working capital for your business, for medical emergency, or any other emergency.|
|Eligibility||You need to be at least 21 years old at the time of applying for the loan. You should be able to demonstrate a consistent source of income and employment stability and reasonable credit health.||Ideally, the applicant needs to be salaried or self-employed with a good net income, needs to have a good credit history, and fall in the age bracket of 21-65 years.|
|Loan amount||The customer can get a loan amount that is a certain percentage of the value of the asset that has been pledged. For instance, you can get up to 80% of the value of the property that you are buying, subject of course to certain conditions. Similarly, you can get up to 60% of the value of the property you are mortgaging for a Loan against Property.||The personal loan amount could range from a few thousand rupees to a couple of lakhs depending on several criteria like your income, requirement, employer profile, credit history, lender’s lending policies, etc.|
|Interest rates||In general, interest rates on secured loans are lower than an unsecured loan, since lenders have your asset as collateral to safeguard their money in case of default.||A personal loan/unsecured loan is one of the costliest loans in the market. Its interest rate could go anywhere up to 30% per annum or even more, depending on your credit situation. Similarly, interest rates on your credit card outstanding can be extremely high.|
|Process||A secured loan might take some time to be approved and disbursed. It depends on the type of loan you are applying for. For example, a home loan might have detailed documentation requirements, and it can take time for all the legal, credit and personal issues to be processed. On the other hand, a gold loan has a simple application process and the loan amount can be disbursed on the same day if everything is found to be in order.||Unsecured loans can take much less time as there is less documentation involved – e.g. no legal approvals in the case of a home loan. Some banks even offer instant loans, subject to certain conditions.|
|Tenure||Secured loans are medium to long term loans and the repayment period can range from a few years to a couple of decades, depending on the lender and type of loan.||Both unsecured and secured loans have their advantages and disadvantages. You need to decide for what purpose you need the loan and choose accordingly.|
Difference between Secured and Unsecured Loan
- The most important difference between a secured and unsecured loan is the collateral required to attain the loan. A secured loan requires you to provide the lender with an asset that will be used as collateral for the loan. Whereas an unsecured loan doesn’t require you to provide an asset as collateral in order to attain a loan.
- Another key difference between a secured and unsecured loan is the rate of interest. Secured loans usually have a lower rate of interest when compared to an unsecured loan. This is because unsecured loans are considered to be risker loans by lenders than secured loans.
- Secured loans are easier to obtain while unsecured loans are harder to obtain, as it is less risker for a banker to dispense a secured loan.
- Secured loans usually have longer repayment periods when compared to unsecured loans. In general, secured loans offer a borrower a more desirable contract than an unsecured loan would.
- Secured loans are easier to obtain for the mere fact that they are less risky for a lender to give out, while unsecured loans are comparatively harder to obtain.