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Loans generally belong to one of two categories: secured loans and unsecured loans. Secured loans require the borrower to offer collateral against which lenders issue a loan. Unsecured loans are given on the strength of the borrower’s credit.
While collateral is the critical difference between these loans, they have other distinctions too. This article will explore how secured loans and unsecured loans differ from each other.
Collateral
When a borrower applies for an unsecured loan, lenders closely examine factors like their credit, verifiable income, and current debt. Good credit and a low debt-to-income ratio are usually enough to satisfy a lender that the applicant is a good candidate for an unsecured loan. Student loans and most personal loans in Canada tend to be unsecured loans.
Applicants borrowing substantial sums or those with poor credit must provide collateral to help decrease the lender’s risk in issuing them a loan. The lender can seize their collateral if they fail to repay the loan. Mortgages, home equity loans, and car title loans are common examples of secured loans.
Interest rates
Secured loans usually carry lower interest rates. Hence, they are less risky for lenders who can quickly recover their funds by claiming the borrower’s collateral.
However, if the borrower defaults on an unsecured loan, the lender must begin a long collections process to recover the funds. Thus, the risk is on the lender’s side. Good credit mitigates some of the lender’s risk, so they offer borrowers with good credit lower interest rates on unsecured loans.
Processing time
Unsecured loan applications may take a week or two to process and approve. Lenders may have varying timelines, but typically, unsecured loans take little time to process.
Secured loans may take longer to process since there are additional steps involved. The lender must process and verify the collateral, which can take a while, especially for mortgages and home equity loans.
Borrowing limit
Applicants opting for secured loans may be eligible to borrow more funds than those applying for unsecured loans. That said, the borrowing limit may be contingent on the collateral offered and the lender’s policy.
Someone borrowing against the value of their house can access more money than someone borrowing against their car. For comparison, most lenders offer unsecured loans to a maximum of $50,000 in Canada.
Credit requirements
Borrowers with bad credit usually have more success applying for secured loans than unsecured loans. Bad credit makes any borrower a risky prospect for a lender. While some lenders specialize in issuing unsecured loans to people with bad credit, most will reject applicants with bad credit. However, as collateral takes away much of the risk for a lender, they’re usually willing to issue secured loans to borrowers with less-than-perfect credit.
Ultimately, borrowers must consider their financial situation to determine what type of loan is the right choice for them.
