Secured and unsecured loans are similar yet very different, making it challenging to choose one.
A secured loan requires collateral, such as a car or home, to secure the loan, while an unsecured loan does not require collateral.
The product you choose can have a significant impact on your finances.
In this article, we'll take a closer look at the differences between both by exploring their advantages and disadvantages. We'll also provide tips to help you decide which type is right for your business.
What's The Difference Between Secured And Unsecured Loans?
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What Is A Secured Loan?
Secured debt requires the borrower to offer collateral, which are assets that guarantee that the person will repay the loan.
This way, the lender assumes less risk.
There is also cross collateralization.
What Does Collateral Mean?
Collateral is an asset that a borrower offers as security for a loan.
If the borrower stops making payments on the loan, the lender can seize the collateral to recoup its losses.
Borrowers with bad credit may need to provide more collateral than those with good credit.
Common types of collateral include:
- savings accounts
- other high-value assets
The collateral can include personal or business assets.
Typically, secured loans have a lower interest rate than unsecured loans
since the lender uses collateral to secure the loan.
The interest rates on secured business loans can range from 4% to 15%, with an average rate of around 7% to 8%. However, rates may be higher or lower depending on the lender, the amount of collateral provided, and the borrower's credit history.
Additionally, some lenders may charge additional fees, such as application fees, origination fees, or prepayment penalties, which can increase the overall cost of the loan.
Generally, secured business loans offer higher borrowing limits than unsecured loans because they are backed by collateral.
The borrowing limits for secured business loans can range from $25,000 to $5 million or more, with an average borrowing limit of around $250,000 to $500,000.
Secured loans can be easy to qualify for because the collateral you put up to secure the loan can serve as a way to offset any creditworthiness issues you have.
The lender will also consider your credit score
, income, employment history, and other factors when determining whether or not to approve your loan.
Some lenders will appraise the collateral to offer a loan amount equal to the property's appraised value. The lender will then place a lien on the property in question.
Typically, the repayment term on secured loans is longer
, at least when compared to unsecured loans.
The repayment period for secured business loans can range from one to twenty-five years, with an average repayment period of around five to ten years.
You have to make monthly loan payments over a previously set period of years. The lender sets these rates when you sign the loan agreement, which can be fixed or variable.
Secured loans are less costly than unsecured loans because of the collateral.
Should you default (fail to make payments) on the loan, the lender can legally seize the assets used to secure the loan
. Since the lender may repossess or initiate foreclosure proceedings, your credit report may show negative entries.
You must still pay the loan balance if the sold assets don't cover the loan amount.
Types Of Secured Loans
- Secured personal loans
- Secured business loans
- Home equity loans or lines of credit
- Auto loans
- Secured credit cards
Advantages Of Secured Loans
The main advantage of secured debt is that it usually comes with lower rates than unsecured loans.
This is because the lender has less risk.
Also, they typically allow you to borrow larger amounts than unsecured loans. And if you have a poor credit score or a limited credit history, it may be easier to obtain a secured loan than an unsecured one.
This is because the lender has the security of the collateral to fall back on if you cannot repay the loan.
Cons Of Secured Loans
The downside is that many people don't have assets to use as collateral
If they do, they're putting those assets at risk.
You could lose your home or vehicle if you cannot make the payments.
A lower interest rate and being able to borrow more money are appealing, but incurring loan costs longer means you could end up paying more over the long run.
Some types of secured debt are self-secured. This means you don't have to put up collateral because the thing you buy with the loan is the collateral itself
For example, an auto loan
will allow you to purchase a vehicle that becomes the collateral itself.
Other types are:
How To Pay Off Secured Debts
Some tips to pay off secured debts include:
- reviewing the loan terms
- prioritizing high-interest loans
- making extra payments
- considering refinancing
It requires discipline and a solid plan to become debt-free and achieve financial stability.
What Happens If You Can't Pay Back A Secured Loan?
For secured loans such as mortgages
or auto loans, lenders may try to repossess the asset (e.g., home or car) you used as collateral to recoup their losses.
What Is An Unsecured Loan?
Unsecured debt doesn't require collateral to secure the loan.
Therefore, there are no assets to seize if you fail to make payments.
Lenders can process unsecured loans within days compared to secured loans, which take considerably longer.
The lender's interest rate is generally higher than you would pay for a secured loan
The interest rates on unsecured business loans can range from 6% to 36%, with an average rate of around 10% to 12%.
The amount of money you can borrow may be lower
because you don't offer collateral to secure the loan (unless you have a perfect credit score).
The borrowing limits for unsecured business loans can range from $1,000 to $500,000, with an average borrowing limit of around $50,000 to $100,000.
In the loan application process
for unsecured debt, most lenders require that you have a good credit history and a reliable source of income
. They will review your employment history and other factors.
Most of the time, requirements are more stringent due to the lack of collateral. Why? The lender needs to make sure you won't default on the loan.
At Camino Financial, we have minimal requirements.
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Since it's an unsecured loan, you usually pay off the debt more quickly
The repayment period for unsecured business loans can range from three months to five years, with an average repayment period of around one to three years.
One of the biggest risks of taking out an unsecured loan is that you could owe a lot of money to the lender, and your credit score will take a hit.
If you can't pay, the lender can still take you to court and get a judgment against you. This means the lender could garnish your wages or put a lien on your property.
Some lenders who offer unsecured loans require borrowers to sign a personal guarantee agreement.
If the business can't repay the loan, the person signing the guarantee pledges to pay the balance.
Types of Unsecured Loans
- Unsecured personal loans
- Unsecured business loans
- Debt consolidation loans
- Student loans
- Lines of credit
- Unsecured credit cards
Advantages of Unsecured Loans
Unsecured debt doesn't require collateral, making them a good option for borrowers with no assets to use as collateral or who don't want to put their assets at risk
Also, taking out an unsecured loan and making timely payments can improve your credit score and build a positive credit history.
Cons of Unsecured Loans
On the downside, they may have higher interest rates than secured loans and may not be available to borrowers with bad credit.
And if you default, the lender can't take your property as collateral.
Also, because there is no collateral to secure the loan, lenders may limit the amount of money you can borrow with an unsecured loan.
How To Pay Off Unsecured Debts
Some tips to pay off unsecured debts are:
- create a budget
- prioritize debt
- consolidate if possible
- use any extra money towards paying off the debt
What Happens If You Can't Pay Back An Unsecured Loan?
For unsecured loans, lenders can pursue legal action, such as taking you to court or even garnishing your wages if you fail to make payments for an extended period.
There are short- and long-term consequences if you cannot repay a loan.
Is It Better To Get A Secured Or An Unsecured Loan?
It will depend on your needs and situation.
Your most considerable risk is putting up collateral to secure the loan.
By doing so, you may lose your personal or business assets if you can't repay the loan.
Most business owners are reluctant, and rightly so, to offer collateral in exchange for borrowing money. They'd rather get unsecured funding.
If you're still uncertain about what to do, another solution would be to find a lender who doesn't require collateral, has minimal requirements, and charges reasonable interest rates.
Camino Financial Unsecured Business Loans
Camino Financial doesn't ask for collateral.
We offer unsecured business loans to give easier access to capital to entrepreneurs that don't have assets to back up a loan.
Here are some of our benefits:
- Possibility of loan renewal. After 12 timely payments, you can qualify for a loan renewal.
- Fewer requirements. Not only is collateral not required, but also we have fewer business loan requirements than most lenders.
- Fast processing. Once we approve your loan, we'll deposit the funds in your account within 2-10 days.
- No SSN required. You can qualify for a business loan even if you don't have a Social Security Number. You can use an ITIN.
- Limited restrictions on how you use the funds. Our loan restrictions are minimal, so you can use funds to meet your business's needs.
- Pay off the loan early. We don't charge prepayment penalties when you fully pay off your loan before the term ends.
- Bilingual customer service. Our loan representatives speak both English and Spanish.
We recommend that you apply for an unsecured business loan today and reap the numerous rewards we offer. Submitting your application won't affect your credit score.
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Frequently Asked Questions
What are the main advantages of a secured vs. unsecured loan?
The main advantage of a secured loan is that it often offers lower interest rates and higher borrowing limits because the lender has collateral to secure the loan.
Additionally, secured loans can be easier for individuals with poor credit because the collateral reduces the lender's risk.
Why is an unsecured loan better?
Because they don't require collateral, you don't risk your assets.
Do unsecured loans hurt your credit?
Taking out an unsecured loan and making timely payments can help improve your credit score and build a positive credit history.
However, if you miss payments or default on a loan, it can hurt your credit score and make it more challenging to borrow money in the future.
Is a personal loan secured or unsecured?
A personal loan can be both secured and unsecured.
Do secured loans build credit?
Yes, secured loans can help build credit if you make payments on time and in full. When you take out a secured loan, such as a car loan or a mortgage, the lender reports your payment history to the credit bureaus.
Making timely payments can help establish a positive credit history and improve your credit score.
Are small business loans secured or unsecured?
Depending on the lender, you can find secured or unsecured small business loans.