If you're new to bank loans, it’s important to learn the two main types of loans that most lenders offer: secured and unsecured. Both types of loans offer a lump-sum payment that borrowers must repay in fixed monthly installments over a set term. However, they have some key differences, such as the presence of collateral, which borrowers should know.
What is an unsecured loan?
An unsecured loan is a loan that requires no collateral. Lenders rely on factors such as the borrower's creditworthiness and income to determine whether the borrower qualifies.
Types of Unsecured Loans
You may already be familiar with some common types of unsecured loans. Here are two popular examples:
Personal loans offer a one-time lump sum that can be used for almost any purpose. They’re also usually easy to apply for online.
Personal loans are repaid in fixed monthly installments over a specified period.
Debt Consolidation Loans
Debt consolidation loans can be helpful for someone who needs to repay multiple loans or credit card balances.
You can mainly use these loans to replace multiple monthly payments with just one. They’re also particularly helpful when they offer a lower interest rate than your current debt.
Benefits of Unsecured Loans
Unsecured loans offer key benefits that make them a practical choice for anyone who meets the lender’s requirements.
No collateral is needed
You don't need any assets to act as collateral. You can be approved for an unsecured loan as long as you meet your lender’s standards for creditworthiness and income, even if you don’t own assets like a house or car.
Easy application process
Many lenders allow you to obtain an unsecured loan through a short and simple online application process.
Risks of Unsecured Loans
As with any debt, there is a certain amount of risk involved with borrowing an unsecured loan. These are the risks borrowers incur with these types of loans:
Reduced credit score
If you default on an unsecured loan, your creditworthiness may be affected. This type of mistake makes it harder to borrow in the future should the need arise.
Since unsecured loans are riskier for the lender, they may charge higher interest rates than a secured loan. Like borrowing limits, rates are based on the borrower’s credit, so you may not receive an ideal interest rate if you don’t have good credit. Higher rates can also influence monthly payments and loan terms.
Where do you get an unsecured loan?
Unsecured loans are usually offered by banks, credit unions and online lenders. You may have come across unsecured loans by other names such as personal loans, home improvement loans, debt consolidation loans or medical loans.
Most of these lenders evaluate your eligibility through a simple online evaluation process that may require you to share personal information about your creditworthiness, annual income or any possible investments or savings. If you are pre-approved, you can get an idea of the rates and loan terms available.
Citi accepts personal loan applications online and responds in less than 60 seconds. Once approved, the funds are deposited into your account the same day.
What is a secured loan?
A secured loan is backed by collateral—usually an asset like a home or car—that the lender can claim if the borrower doesn’t repay the loan.
Types of Secured Loans
When it comes to secured loans, there are a few options available, such as:
A mortgage is a home loan secured by the house you’re buying. So, the home you've purchased is the collateral, and you fully own it once you have paid off the mortgage. Mortgages usually last 15 to 30 years with rates determined by various factors like your credit score, home price, and location.
A home equity line of credit or HELOC is an open line of credit secured by a home that you fully or partly own. You borrow against your equity in the house during a draw period and repay the borrowed amount once the draw period has ended.. HELOCs tend to have variable interest rates that may be riskier for some borrowers.
With an auto loan, the lender provides funds to pay for the car upfront. The borrower then repays the lender in fixed installments over a specified term. In the interim, the car you've purchased is the collateral lenders can repossess if you default on the loan.
Benefits of Secured Loans
If you're considering a secured loan, these are some benefits worth considering.
Since secured loans reduce the risk for the lender, borrowers may be eligible for lower interest rates. Note that the value of your collateral will impact your rates too.
Easier to qualify
Since the presence of collateral makes secured loans less risky for lenders, lenders may still offer a secured loan to those with comparatively poorer credit.
Higher borrowing limits
Secured loans may give borrowers access to higher borrowing limits. Keep in mind, though, that they have less flexibility than an unsecured loan.
Risks of Secured Loans
Secured loans come with risks that borrowers should be aware of before submitting a loan application.
Loss of assets
The major concern about secured loans is the possibility of losing collateral. This may happen if the borrower cannot repay the borrowed sum.
Damage to your credit
If a borrower defaults on a secured loan, not only will they lose their collateral, but they may also damage their credit, which can make future borrowing harder.
Where do you get a secured loan?
Most banks, credit unions and online lenders offer secured loans. It’s a good idea to investigate preapproval options to get an idea of the rates available to you as you compare your choices.
The application process may include more steps than unsecured loans such as an appraisal of the collateral. The appraisal process may lengthen your application process, but this may differ from one lender to the next.
Secured vs. Unsecured Loans: Which is Better for You?
The purpose of borrowing is the most important factor when it comes to loans. To buy a house or car, you will most likely use a mortgage or an auto loan. These are secured loans and are the most common when it comes to certain large purchases.
However, with more flexible options like HELOCs or personal loans, your credit and financial situation will help determine the better loan for you. Secured borrowing may also be the more convenient choice for someone with poor credit.
Unsecured loans may be the better alternative for someone who does not want to risk losing their assets. No collateral may mean slightly higher interest rates, but the tradeoff may be worthwhile for some borrowers.
Frequently Asked Questions
Can you change a secured loan to an unsecured loan?
An existing secured loan typically cannot be changed or refinanced with an unsecured loan.
Can you pay off a secured loan early?
Most lenders will let you pay off a personal loan early. However, some lenders may charge prepayment fees to those who pay off loans early. Ask your lender about prepayment penalties as early as possible during your application process.
How do secured and unsecured loans affect your credit?
Both secured and unsecured loans can be tools to help improve your credit. By making timely loan payments on both types of loans, you can help improve your credit.
Late and missed payments on either type of loan cause credit damage, and remain in your repayment history for up to seven years. The same applies to foreclosures (secured loans) and accounts sent to collections (unsecured loans).
Disclaimer: Citi offers personal loans to both existing Citi customers and new Citi customers that meet specific eligibility criteria, including an established credit and income history along with additional factors determined by Citi. If you think you could benefit from a Citi Personal Loan, apply online today.
Disclosure: This article is for educational purposes. It is not intended to provide legal, investment, or financial advice and is not a substitute for professional advice. It does not indicate the availability of any Citi product or service. For advice about your specific circumstances, you should consult a qualified professional.