Secured Vs Unsecured Loans: Selecting the Best Option for Your Needs
Ketki Jadhav
Jun 20, 2023 / Reading Time: Approx. 5 mins
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You may frequently come across the term 'Secured Loan' and 'Unsecured Loan', often through unsolicited messages and calls from different financial institutions. However, a limited number of individuals genuinely understand the fundamental differences between these loan categories.. Nevertheless, being aware of the differences between secured and Unsecured Loans is crucial to becoming financially literate. Such knowledge can prove beneficial when facing financial difficulties and requiring access to either of these loan options. This article elucidates what secured and Unsecured Loans are, outlines the difference between Secured Loans vs Unsecured Loans, and explains factors you should consider when choosing between the two, so you can make an informed choice when seeking financial assistance.
What Are Secured Loans?
To understand the concept of Secured Loans, you should first know what collateral is. When availing of a Secured Loan, you are required to provide a valuable asset as collateral. Collateral is a necessity for Secured Loans like Home Loans or Gold Loans. For example, in the case of a Home Loan, the house itself serves as the collateral, whereas in the case of a Gold Loan, you pledge the gold to the lender to get the funds, which can be used for any purpose. Some more examples of loans that necessitate collateral are Car loans, Two-wheeler loans, Loans against property, Home renovation or Top-up Home Loans, Loans against securities, and Home construction loans.
When a borrower provides an asset as collateral for a loan, it is known as a Secured Loan. The lender places a lien on the collateral when you obtain a Secured Loan. Once the loan is fully repaid, the lender removes the lien, and you become the sole owner of the asset without any encumbrances. However, if you fail to make timely loan repayments or default on the loan, the lender has the right to seize the collateralised asset in order to recover the outstanding dues.
What Are Unsecured Loans?
An Unsecured Loan does not require collateral as a guarantee. If you fail to repay such a loan, the lender does not have the direct authority to seize your property in order to recover the dues. Some common examples of Unsecured Loans include Personal Loans, credit cards, Student Loans, and Small Business Loans. Generally, you need a stable income and a good credit history to qualify for an Unsecured Loan. However, due to the absence of collateral, Unsecured Loans typically carry higher interest rates compared to Secured Loans like home and car loans. Hence, you should thoroughly understand your financial situation before applying for an Unsecured Loan.
What Is the Difference Between Secured Loans And Unsecured Loans?
| Secured Loans |
Unsecured Loans |
| These loans are typically high-amount loans, so they require collateral, i.e., an asset to pledge, to secure the loan. |
As the name suggests, these loans are unsecured; hence, no collateral is required. |
| Providing Secured Loans is less risky for the lenders as they have collateral. Hence, these loans are available at lower interest rates compared to their counterparts. |
Since Unsecured Loans are provided without collateral, they are comparatively riskier for the lender. Therefore, the interest rates of these loans are on the higher side. |
| Since the lender has to verify the asset, do the valuation of the asset and do the necessary documentation, the processing of Secured Loans generally takes a longer time. |
Unsecured Loans are known for their quick and easy loan processing. |
| The loan amount depends upon the value of the collateral and may range between 50% to 100% of the value of the collateralised asset, depending on the type of asset and the lender's terms. |
The loan amount mainly depends upon the borrower's income, repayment capacity, and credit score. However, depending upon the type of loan and lender, there is a maximum limit on the loan amount that can be availed of. |
| In case the borrower is unable to make the repayment on time, their collateralised asset is at risk. |
There is no such risk. |
What Are the Factors You Should Consider When Choosing Between Secured vs Unsecured Loans?
1. Risk of Losing Collateral:
Collateral plays a crucial role in the case of a Secured Loan. For instance, you might offer your house as collateral to get a Loan Against Property to start a new business or use your mutual fund investments as security to avail of a Loan Against Securities to pay your child's school fees. Lenders may have a minimum value requirement for the collateral, and the value of your security will typically exceed the loan amount offered to you. Hence, it is advisable to consider how confident you are about your repayments and whether you are ready to take the risk of pledging valuable assets as collateral.
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2. Required Loan Amount:
Secured Loans generally come with higher loan amounts and longer loan tenures. For example, a Home Loan can have a longer loan tenure of up to 25 to 30 years. Whereas Unsecured Loans are offered based on factors like your income, credit score, repayment capacity, and specific eligibility criteria set by the lender. As a result, Unsecured Loans come with limitations on the loan amount and tenure, which are usually shorter compared to Secured Loans. Therefore, you should analyse your financial requirements and select the loan type that suits you the best. For example, if you need a loan for your child's education abroad, it makes sense to opt for a Secured Education Loan as you can get a higher amount with a Secured Loan, and the interest rate will also be affordable.
3. Available Time in Hand:
Unsecured Loans, being collateral-free, can be obtained on easier and quicker terms, making them suitable for immediate needs like medical emergencies. However, if you have long-term plans, such as starting a new business or buying a second home, you will require substantial funds over a longer period. In such cases, Secured Loans like Loans Against Property or Home Loans can be more advantageous. Keep in mind your specific timeframe for meeting your financial requirements when considering the type of loan to pursue.
4. Your Credit Score:
When you take an Unsecured Loan, your credit score is significant as it is the primary way a lender can judge your creditworthiness. A good credit score above 750 will get you a high-value loan sanction at a more competitive interest rate. On the other hand, alongside your credit score, your asset is the key to getting you a hefty sanction on flexible loan terms when you avail of a Secured Loan. So, if your credit score is not good, it may be more affordable for you to opt for a Secured Loan. If your needs are not urgent, it is advisable to first improve your credit score and then opt for an Unsecured Loan.
To conclude:
When deciding between a Secured Loan and an Unsecured Loan, you should make sure you select the option that aligns with your specific needs. Secured and Unsecured Loans come with distinct offerings and features. Hence, it is advisable to clearly understand both types of loans to make an informed decision. Furthermore, before applying for any loan, analyse your repayment capacity and affordability. This ensures that you can comfortably meet the loan obligations without financial strain.
KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision.