If you are searching for a loan, you will likely come across two primary categories: secured and unsecured loans.

There are significant differences between these loans in terms of interest rates, borrowing limits, risk factors and of course, collateral requirements. So that you can make informed borrowing choices, it is important to understand the key differences between these loans. Let's explore more about these loans to help you navigate loan options with confidence.

Secured loans

Secured loans require collateral, which is an asset of value such as a car, property or savings account. This collateral serves as a security for the lender in the even the borrower defaults on the loan.

Key aspects of a secured loan

1. Required Collateral: To get a secured loan, you will need to pledge an asset as collateral. The value of this asset will be considered when determining the maximum amount you can borrow. It's important to note that If you default on the loan, the lender has the right to seize and sell this asset to recover their funds.

2. Lower Interest Rates: As the collateral helps mitigate the lender's risk they may be more willing to offer lower rates, as such you're likely see secured loans offering a lower interest rate in comparison to unsecured loans. As the interest rate is generally fixed for the term of the loan, your monthly repayments will remain stable throughout the agreement.

3. Higher Borrowing Limits: With a secured loan, the loan limit depends on the value of the collateral and the borrower's ability to repay. You will often find that these loans generally allow borrowers to access higher loan amounts than an unsecured loan. This may make it a suitable option for larger expenses, such as home renovations or a property purchase.

4. Longer Repayment Terms: Longer repayment periods, spanning several years are often seen with a secured loan. For larger loan amounts, this can help with managing monthly repayments.

Unsecured loans

Also known as personal loans, an unsecured loan does not require any collateral, instead eligibility is typically based on the borrower's creditworthiness and income.

Key Aspects of an unsecured loan

1. No Collateral Required: With an unsecured loan you do need to pledge any collateral, making them an option for borrower's who do not want to put their assets at risk, or who may not own any assets of significance.

2. Higher Interest Rates: To compensate for the increased risk of lending without collateral as security, lenders may charge higher interest rates for an unsecured loan. Depending on the terms of the loan and the credit profile of the borrower, the interest rate can be fixed or variable.

3. Lower Borrowing Limits: In comparison to secured loans, unsecured loans generally offer lower borrowing limits. The loan amount will be defined by factors such as the borrower's income, credit history and the lenders assessment of their ability to repay.

4. Shorter Repayment Terms: With an unsecured loan, the repayment terms is usually a few years, so you may see higher monthly repayments but a shorter repayment period.

5. Creditworthiness Matters: When approving an unsecured loan, a lender will consider the borrower's creditworthiness and their ability to repay. The chances of approval and favourable interest rates may increase if you have a good credit history, a stable income and a low debt-to-income ratio.

Choosing between secured and unsecured loans

The decision between taking a secured or an unsecured loan very much depends on your individual circumstances and borrowing needs. Take some time to consider the following factors:

1. Loan Amount: There a generally higher borrowing limits associated with collateral-backed loans, so if you are looking for a substantial loan amount a secured loan may be more suitable for you.

2. Creditworthiness: If you have a stable income and a strong credit history, you find competitive interest rates and more desirable options for unsecured loans.

3. Collateral Risk: A secured loan could put your collateral at risk. Decide if you are truly comfortable putting your assets at risk in the even of a loan default.

4. Interest Rate: Taking into account your creditworthiness and the total cost of borrowing over the loan term, assess the interest rates for both secured and unsecured loans.

5. Repayment Ability: Consider it you are able to comfortably make higher monthly payments for an unsecured loan with a shorter repayment term, or if it would be more suitable for you to have a secured loan with a lower monthly payment over a longer time.

There are significant differences between secured and unsecured loans - requirements of collateral, borrowing limits, repayment terms and interest rates. Although secured loans may provide access to higher loan amounts at lower interest rates, they require collateral and you are at risk of your assets being seized. In comparison, unsecured loans come with higher interest rates and lower borrowing limits, but they do not require any collateral.

To determine the most suitable loan option for you, evaluate your financial situation, borrowing needs and risk tolerance. Take into account factors such as loan amount, interest rates, repayments terms and your creditworthiness.

Editorial Disclaimer: This article was updated 09.07.2023.

Opinions expressed here are the author's alone, and not those of any bank, credit card issuer or any other company. This article has not been reviewed, approved or otherwise endorsed by any of these organisations.

NB: The information on this page does not constitute financial advice, please do your own research to ensure that the product / service is right for your individual circumstances.