Loans tend to belong to one of two major categories: secured or unsecured. It’s important to know which type of loan you have because the way they’re managed and the consequences for missing payments are different. Find out more about what unsecured loans are below and how they differ from secured loans.
What Are Unsecured Loans?
Unsecured loans are those that aren’t secured by collateral or surety. That means that they aren’t tied to property or something of value, such as land, a home or a vehicle.
What Are Secured Loans?
Secured loans are loans that are secured by collateral or surety. They are tied to property.
In many cases, this is because the loan was taken out specifically to buy the property in question. The lender holds the title to the property until you pay off the loan, at which the title is transferred to you fully. This is the case with loans for houses or vehicles, for example.
Other times, secured loans require collateral. You agree with the lender to designate something of value you own — such as jewelry, furniture, art or even a vehicle or boat — as collateral. If you fail to make payments on the loan as agreed, the lender has the legal right to take those items and sell them to recover their loss.
Major Differences Between Unsecured and Secured Loans
Collection of Debt After Default
The biggest difference between these two types of loans is that secured loans are backed by property and unsecured loans are not. That means if you default on a secured loan, the lender has the right to take the property in question. It may do so in a foreclosure, repossession or seizure, depending on the specifics of the loan. Once they’ve taken possession of the collateral, the lender then sells the items it takes and uses the money to offset the loss it incurred by nonpayment of the debt.
With an unsecured loan, the lender doesn’t have this option. Instead, it has to pursue other collection activities, which can extend to filing a lawsuit against you and seeking a judgment. If the lender or collection agency gets a judgment, they may be able to garnish your wages or levy your bank accounts to get the money owed to them.
It’s important to note that just because you have a secured loan doesn’t mean lenders won’t file a lawsuit and seek further action against you. They may take the collateral and liquidate it, finding that they were not able to sell it for enough to cover the entire debt. In such a case, you may still be on the hook for the remaining funds.
While the interest rate you’re able to get on a loan depends on many factors, including your own credit history, secured loan terms are often more favorable in general than unsecured loan terms.
This is true because a loan is secured by property is one that is less risky for the lender. As discussed above, the lender is able to take the property securing the loan and sell it to recover some (if not all) of its losses if you don’t pay as agreed. Because of this, some lenders are able to offer lower interest rates on secured loans.
Treatment in Bankruptcy and Other Proceedings
Secured and unsecured debts are also treated differently in bankruptcy and other proceedings surrounding financial matters. For example, if you want to keep your property, you may be able to make arrangements to prioritize secured debts in a bankruptcy proceeding. This means that you would still make payments on those debts while seeking the benefits of bankruptcy in discharging unsecured debts.
Should You Get an Unsecured Loan?
Which type of loan is right for you depends on your personal needs and options. But an unsecured personal loan can be a flexible financial tool that’s right for many people. Here are just a few reasons you might want to seek an unsecured personal loan.
You Want to Build Your Credit
One of the factors that contribute to your credit score is credit mix. This refers to whether or not you have multiple types of accounts in your credit history.
You can have revolving accounts and installment accounts. Revolving accounts include things such as credit cards and lines of credit, where you draw on a credit line and pay it back in an ever-revolving fashion. Installment accounts refer to debts such as unsecured personal loans or car or mortgage loans. You pay installment accounts back with agreed-upon periodic payments.
Potential future lenders like to see that you can responsibly handle both types of accounts. Thus, having a good mix of credit types on your report can potentially boost your score. If you only have revolving accounts, you might take out a personal loan to balance your credit mix.
A history of timely payments can also help build your credit. This is the top factor in determining your score, so taking out an unsecured loan when you have little history of credit and paying it back as agreed can help boost your score.
You Need the Funds
The other common reason for taking out an unsecured loan is a need for funds. Personal loans can be processed quickly — those approved for funds from Wise Loan may be able to receive them as soon as the same day!
The speeds at which these loans can be processed on top of the fact that they don’t require security make them a flexible financial solution for many people. You might apply for an unsecured flexible loan to get funds for:
- Filling in a temporary financial gap, which allows you to cover necessary living expenses or bills until you get paid again
- An unexpected urgent expense such as medical bills or a car or home repair
- A large personal expense you want to spread out over a few months of payments, such as a new computer or vacation
Whether or not you should get an unsecured loan is a personal decision. Make sure you consider your financial situation and whether you can afford to pay the loan back. Then, choose a reputable and responsible lender and avoid applying for numerous loans at the same time, as that can cause many hard inquiries on your credit report. If you’re ready to apply for an unsecured loan today, Wise Loan can help.