A “secured” personal loan is backed by an asset, called collateral, such as a home or car. An unsecured loan, on the other hand, is not collateralized, which means that no underlying asset is necessary to qualify for financing. Whether someone should pursue a secured or unsecured loan depends on a number of factors, such as their credit score and whether they have assets to put up as collateral.
If you’re planning to take out a loan, it’s important to do your research and find one that best fits your needs and financial situation. Learn more about when someone can and should take out a collateral loan.
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Why Secured Loans Require Collateral
With a secured personal loan, a lender is typically able to offer a larger amount, lower interest rate, and better terms. That’s because if the loan isn’t repaid as agreed, the lender can take possession of the collateral. This is not the case with an unsecured personal loan.
Collateral allows secured personal loans to be offered to a wider range of consumers, including those who are considered higher risk. The reason is that the lender’s risk is offset by the borrower’s assets.
Fixed Rate vs Variable Rate Loans
There are other types of personal loans beyond secured versus unsecured. One important distinction is whether a loan has a fixed or variable interest rate. A fixed rate is just as it sounds: The interest rate stays fixed throughout the duration of the loan’s payback period, which means that each payment will be the same.
The interest on a variable-rate loan, on the other hand, fluctuates over time. These loans are tied to a benchmark interest rate — often the prime rate — that changes periodically. Usually, variable rates start lower than fixed rates because they come with the long-term risk that rates could increase over time.
Installment Loans vs Revolving Credit
A personal loan is a type of installment loan. These loans are issued for a specific amount, to be repaid in equal installments over the duration of the loan. Installment loans are generally good for borrowers who need a one-time lump sum.
An installment loan can be either secured or unsecured. A mortgage — another type of installment loan — is typically a secured loan that uses your house as collateral.
Revolving credit, on the other hand, allows a borrower to spend up to a designated amount on an as-needed basis. Credit cards and lines of credit are both forms of revolving credit. If you have a $10,000 home equity line of credit (HELOC), for example, you can spend up to that limit using what is similar to a credit card.
Lines of credit are generally recommended for recurring expenses, such as medical bills or home improvements, and also come in secured and unsecured varieties. A HELOC is often secured, using your house as collateral.
What Can Be Used as Collateral on Personal Loans?
Lenders may accept a variety of assets as collateral on a secured personal loan. Some examples include:
House or Other Real Estate
For many people, their largest source of equity (or value) is the home they live in. Even if someone doesn’t own their home outright, it is possible to use their partial equity to obtain a collateral loan.
When a home is used as collateral on a personal loan, the lender can seize the home if the loan is not repaid. Another downside is that the homeowner must supply a lot of paperwork so that the bank can verify the asset. As a result, your approval can be delayed.
Bank or Investment Accounts
Sometimes, borrowers can obtain a secured personal loan by using investment accounts, CDs, or cash accounts as collateral. Every lender will have different collateral requirements for their loans. Using your personal bank account as collateral can be very risky, because it ties the money you use every day directly to your loan.
Recommended: Secured vs Unsecured Personal Loans — What’s the Difference?
Vehicle
A vehicle is typically used as collateral for an auto title loan, though some lenders may consider using a vehicle as backing for other types of secured personal loans. A loan backed by a vehicle can be a better option than a short-term loan, such as a payday loan. However, you run the risk of losing your vehicle if you can’t make your monthly loan payments.
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Pros and Cons of Using Collateral on a Personal Loans
Using collateral to secure a personal loan has pros and cons. While it can make it easier to get your personal loan approved by a lender, it’s important to review the loan terms in full before making a borrowing decision. Here are some things to consider:
Pros of Using Collateral
• It can help your chance of being approved for a personal loan.
• It can help you get approved for a larger sum, because the lender’s risk is mitigated.
• It can help you secure a lower interest rate than for an unsecured loan.
Cons of Using Collateral
• The application process can be more complex and time-consuming, because the lender must verify the asset used as collateral.
• If the borrower defaults on the loan, the asset being used as collateral can be seized by the lender.
• Some lenders restrict how borrowers can use the money from a secured personal loan.
Qualifying for a Personal Loan
Common uses for personal loans include paying medical bills, unexpected home or car repairs, and consolidating high-interest credit card debt. With secured and unsecured personal loans, you’ll have to provide the lender with information on your financial standing, including your income, bank statements, and credit score. With most loans, the better your credit history, the better the rates and terms you’ll qualify for.
If you’re considering taking out a loan — any kind of loan — in the near future, it can be helpful to work on building your credit while making sure that your credit history is free from any errors.
Shop around for loans, checking out the offerings at multiple banks, credit unions, and online lenders. Each lender will offer different loan products that have different requirements and terms.
With each prospective loan and lender, make sure you understand all of the terms. This includes the interest rate, whether the rate is fixed or variable, and all additional fees (sometimes called “points”). Ask if there is any prepayment fee that will discourage you from paying back your loan faster than on the established timeline.
The loan that’s right for you will depend on how quickly you need the loan, what it’s for, and your desired payback terms. If you opt for an unsecured loan, it might allow you to expedite this process — and you have the added benefit of not putting your personal assets on the line.
Recommended: Is There a Minimum Credit Score for Getting a Personal Loan?
The Takeaway
Using collateral to secure a personal loan can help borrowers qualify for a lower interest rate, a larger sum of money, or a longer borrowing term. However, if there are any issues with repayment, the asset used as collateral can be seized by the lender.
The right choice for you will depend on your financial situation, including factors like your credit score and history, how much you want to borrow, and what assets you can use as collateral.
Looking for a personal loan that doesn’t require collateral? Check out SoFi Personal Loans, which have competitive rates and no-fee options. Apply for loans from $5K to $100K.
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