Secured vs unsecured loans: Which fits your needs, how are they different

Buying an unsecured loan is a better solution if one needs a small amount and there are no assets to pledge

Some purchases or investments cannot be financed through one’s pocket. Loans are a useful financial product in such cases. For buying a house, starting a business, or arranging a wedding, getting a loan relieves a person of financial burden. But it is necessary to have clarity on the different types of loans, broadly known as secured and unsecured. In this article, we will discuss when one should opt for a secured loan and when to go for an unsecured loan.

 

Secured vs unsecured loans

A secured loan is a type of loan that borrowers can get only by providing an asset they own, such as a house or gold, as collateral to the lender. The asset serves as security against the loan. The lender can claim their right over the asset if the borrower fails to repay the loan. Unsecured loans, on the other hand, do not require the borrower to provide any collateral to get the loan. This involves more risk and the interest rates are also higher. 

 

Factors to consider

• Collateral: The borrower has to offer the lender something as collateral to obtain a secured loan, but not for an unsecured loan.
• Interest rate: Secured loans have a lower interest rate due to the collateral, while unsecured loans have a higher interest rate.
• Loan amount: Large amounts borrowed from lenders are typically secured loans that offer higher amounts, whereas unsecured loans are useful when small funds are needed.
• Disbursal: Approval of secured loans takes time due to lengthy verifications, while unsecured loans are processed quickly by lenders. 
• Loan tenure: Unlike unsecured loans, secured loans come with longer repayment tenures and make it easy for borrowers to repay. 
• Risks: Borrowers face the fear of losing the collateral if they default on loan repayment. In unsecured loans, the risk is of lower credit score in case of default. 
• Eligibility: An unsecured loan involves stringent requirements, including a minimum credit score of 750. It is relatively easier to get a secured loan owing to the collateral. 

There are several factors borrowers should check before selecting between a secured and an unsecured loan. 

 

When the loan requirement is large

If the borrower requires a large sum of money, say for buying a vehicle or renovating the house, then secured loans make sense. The reason is that lenders do not hesitate to provide a higher loan amount since the borrower will provide collateral. On the other hand, lenders put a lower borrowing limit on unsecured loans. Thus, borrowers must go for secured loans if the loan requirement is high. They can increase the chances of getting the loan approved by pledging assets like property, a car, or even a mutual fund investment.

 

When borrowers seek affordability and convenience 

Compared to unsecured loans, secured loans come at lower interest rates. This is because the security provided by the borrower lowers the risk for the loan provider. Besides, in secured loans, one has the benefit of a longer repayment tenure. This means lower equated monthly installments (EMIs). So, these loans are more affordable than unsecured loans. 

 

When borrowers need urgent money but without collateral

Going for an unsecured loan is a better solution if one needs a small amount and there are no assets to pledge. These types of loans are processed faster, but borrowers must be mindful of the higher interest rates, which can result in higher EMIs. 

 

How can borrowers protect their credit profile?

Credit bureaus have a complete record of a borrower’s repayment history, outstanding debts, credit score and other details. Borrowers must be disciplined when managing their debts; otherwise, it can impact their credit history. 

 

Forgetting to pay one’s EMI on time can affect credit score and ruin the chances of getting loans in future. Borrowers must make efforts to have a strong credit profile. This will help them get loans at lower interest rates, longer repayment tenure or a higher loan limit. Some basics to keep in mind are: 

• Making credit card bill and EMI payments on time
• Setting up reminders or automated payment to avoid charges
• Refraining from high usage of credit, not exceeding 30%
• Avoiding frequent credit or loan applications
• Reading one’s credit report and checking for any errors
• Balancing secured loans along with unsecured credit for a healthy mix

 

FAQs

What fees and billing cycles are included in secured and unsecured loans?

Loan applicants have to pay processing and other fees when getting loans. For secured loans, the processing fee is usually between 0.5 per cent to 2.5 per cent and this could be higher up to 5 per cent for unsecured loans. The billing cycle for both secured and unsecured loans is monthly. The repayment tenure is based on the loan amount and other factors. However, for secured loans, the repayment tenure is comparatively longer.

 

How will this affect the borrower’s credit score or future eligibility?

A borrower’s credit score or future eligibility suffers if they consistently miss or delay paying their EMIs. The impact is also seen when one applies for new credit cards or loans frequently. 

 

When does prepayment, consolidation, or a balance transfer make sense?

Prepayment of loans, which attract specific charges, makes sense if the borrower has ample funds and wants to reduce their interest burden. Consolidation works when one has multiple high-interest debts. So, they can combine these debts by applying for a new loan. Balance transfers, where a high-interest outstanding loan is moved to a new lender, is often done to reduce interest burden. 

 

Which habits create debt traps or avoidable long-term stress?

Some common habits that put people into debt traps are borrowing unsecured loans frequently for non-essential purchases, applying for too many loans or getting new loans to pay off existing debts.