When the need to borrow money arises, there are several choices to obtain the cash needed, including borrowing from family members, a cash advance on a credit card or a traditional loan from a bank or credit institution. Banks offer both secured and unsecured loans. It is important that borrowers understand the differences between secured loans and unsecured loans before signing any loan documentation. There are pros and cons to both types of loans.
Collateral
The main difference between a secured and unsecured loan is the collateralizing of the loan. With a secured loan, the bank will take possession of the title of the assets that are being used as collateral for the loan. This may include a home, car, investments or other assets that can be converted to cash. With an unsecured loan, there is no collateral provided for the loan. The bank does not gain access to any assets with an unsecured loan, which is generally lent on the strength of the borrower's good name and credit history.
Interest Rate
Because the bank is more at risk with an unsecured loan, the interest rates tend to be higher than with a secured loan. In some cases, the interest rates on an unsecured loan may be higher than that of your credit card. A typical unsecured loan will have a fixed interest rate. It is possible to have an unsecured line of credit, similar to a credit card, which will have a variable interest rate. Regardless, an unsecured loan’s interest rate will be higher than a secured loan where the bank has collateral to repossess if the borrower does not repay the loan.
Term
The term of an unsecured loan tends to be shorter than a secured loan. Again, this is to lessen the risk to the financial institution. Without collateral to mitigate the bank’s risk, the institution wants the money to be repaid as soon as possible. This same reasoning is also why unsecured loans are usually available in much lesser amounts than secured loans. Secured loans, particularly those secured with real estate, can have terms as long as 30 years.
Availability
Not everyone will qualify for an unsecured loan. Many banks will require an excellent credit score as well as an established relationship with the borrower before extending an unsecured loan. In fact, some banks refuse to lend money without collateral and will not even offer overdraft protection for a checking account unless it is tied to a savings account. With a secured loan, those with good credit will qualify and an existing relationship with that financial institution is usually not required.
Tax Implications
With a secured loan, it is possible to write-off the interest associated with the loan. This would hold true if the loan is secured with your primary home as collateral. However, you must also realize that you are putting your home at risk if you are unable to make the payments on the loan. With an unsecured loan, writing off the interest associated with the loan is not possible as it is not collateralized. However, you are also not risking your assets if you are unable to repay the loan.
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