Understand the differences between a secured loan and an unsecured loan, and find out about the advantages and disadvantages of each.

What Is a Secured Loan?

A secured loan is made with a lien against a borrower’s asset. The borrower agrees to secure this type of loan with an agreed-upon asset. If the loan is defaulted upon, the lender has the legal right to reclaim the home or other asset securing the loan. Secured loans are typically made with assets, including: 

- Borrower’s home 
- Borrower’s other real estate 
- Borrower’s car 
- Other valuable assets owned by the borrower

What Is an Unsecured Loan?

As its name implies, an unsecured loan is made without securing any assets of the borrower. Qualification for an unsecured loan is based on the borrower’s credit rating.

There are three types of unsecured loans: 

- A personal unsecured loan requires the borrower to be responsible for repayment. 
- An unsecured business loan requires the business to be responsible for repayment. 
- An unsecured business loan with a personal guarantee at first requires the business to be responsible for repayment, unless the business defaults. If this happens, the individual guarantor becomes responsible for repayment.

Advantages of Secured Loans

A secured loan may feel more risky than an unsecured loan. The thought of losing your home if you default on a loan is a huge risk to take into consideration. Yet secured loans have advantages: 

- The interest rate on secured loans is usually lower than that of unsecured loans. Unsecured loans pose more risk for the lender, and thus, higher interest is charged for an unsecured loan.  
- While the bank has the legal right to take your home (or other securing asset) if you default on a secured loan, it is not always an easy process for the lender to reclaim an asset like a home. If a borrower falls behind on a secured loan, it may be easier for the lender to apply pressure for repayment through a series of letters to the borrower. A lender may avoid – until absolutely necessary – the cumbersome and slow process of reclaiming and selling a home. 

- Default rates are typically lower on secured loans – an advantage for both lender and borrower. Borrowers are highly motivated not to default on a loan that is secured by their large assets.

Disadvantages of Secured Loans

You still run the risk of losing the asset that secures this loan if you default. For many, the prospect of losing their home – even if a highly unlikely prospect – is terrifying.

Advantages of Unsecured Loans 

- If you have a good credit rating, you can leave your assets unencumbered and available for future secured loans.  
- Unsecured loans can be an easy way for small businesses in good standing to get funds quickly for cash flow.

Disadvantages of Unsecured Loans 

- The interest rate on these loans is higher than that for a secured loan.  
- The lender will still have the right to come after your assets (for example: your paycheck, stocks you own, or property you own). Read your loan agreement carefully before signing. 
- The default rate in general is higher for unsecured loans than for secured loans. This is part of the reason that interest rates are higher on these loans.

Understand What You Are Agreeing to When Entering into a Loan Agreement

It goes without saying, but a person should not enter into a loan agreement without completely understanding the terms of the agreement.

Even if you have been approved for a loan, ask yourself the following questions before you sign: 

- Have you read the agreement completely? Do you understand it completely? 
- Can you realistically make the payments, on time, over the life of the loan? 
- Do you completely understand what is at risk for either type of loan? What could you potentially lose? Are you prepared to lose it? 
- Does the loan allow prepayment? Some loans penalize early payments; some do not.

Additional Resources 

- Unsecured Loan Services Web site: http://www.unsecuredloanservices.com  
- America One Unsecured Group Web site: http://www.americaoneunsecured.com 
- Business loan information, articles, and links at http://www.business.com/directory/financial_services/small_business_finance/loans 
- The Washington Post Web site:  http://www.washingtonpost.com/wpdyn/content/article/2008/07/04/AR2008070401398.html