Secured vs unsecured loans: understanding the differences and making the right choice

You’ve got options for pizza. Options for cell phone service. Options for shoes. And yes, options for loans. 

The thing is, the loan you choose will affect your life far more than whether you go for peppers or onions on your pie. But some of the same rules apply—the one your friend thinks is perfect might not be the best for you. 

When it comes to loans, the best option for you depends on a few factors, including how you plan to use the money. Choosing the right loan for you, from personal loans to home equity loans, can be the first step on the path to your financial future.  

What is a secured loan?

A secured loan is backed by collateral. Collateral is a financial asset you own, such as a car or a house. You pledge the asset as a guarantee that you’ll repay the loan. 

Collateral lowers the risk for the lender. If you don’t fulfill your obligation, the lender may have a right to your collateral. This lowers the chance that they’ll have a financial loss. Because the risk is lower, the price is usually lower, too.

Types of secured loans 

You may already have experience with secured loans. For example, a mortgage is a secured loan. The house is the collateral. A car loan is another type of secured loan, where the car is the collateral.

One common type of secured loan is a home equity loan, available to people who own their homes and have equity. Equity measures how much of your home you own. It’s the difference between the current market value of the home and how much you owe on the mortgage if you have one. If you own a home worth $400,000 and you still owe $100,000, you have $300,000 in equity (or 75%). If you don’t have a mortgage, your equity is 100%.

Another option for people who own their home is a home equity line of credit, or HELOC. A HELOC is like a home equity loan except that you don’t have to take the full loan amount in one lump sum. You can borrow what you need, make payments, and borrow more, up to your limit, as often as you want during the first few years that you have the loan. 

Secured loans tend to cost less than loans that aren't backed by collateral. Also, they often have more flexible credit requirements. 

What is an unsecured loan?

An unsecured loan doesn’t require collateral. Instead of pledging something of value to the lender, you’ll qualify based on your creditworthiness, your income, and your other financial obligations. Unsecured loans tend to cost more than secured loans and have higher credit score requirements.

Types of unsecured loans 

Student loans are unsecured loans. So are credit cards. 

Most personal loans are unsecured. Personal loans work like this: you borrow a lump sum of money and pay it back, plus interest, over a predetermined amount of time (you can usually choose a repayment period between 2 and 5 years). The payment is the same every month. Most personal loans have a fixed interest rate, which means your rate is locked in and won't change for the life of the loan. 

Secured vs unsecured loans

Which type of loan is right for me?

Here are a few questions that can help you choose the right type of loan:

Do I have collateral? 

If you own something of value, then a secured loan may be an option for you.

What’s my credit score? 

You may have more options and lower costs with a higher credit score. Collateral will help you if your credit score is lower. You can apply for a home equity loan if your credit score is at least 640.

How quickly do I need the money? 

Personal loans can fund very quickly, within 24 to 72 hours of approval.

If you have a little more time, a HELOC can fund within 15-18 days. 

How much money do I need? 

Generally speaking, home equity loans and HELOCs have higher loan limits than personal loans. Knowing how much money you need can help you assess which option is right for you.

What do I need the money for?

Secured and unsecured loans can both be used to help you pay off credit card debt. You can also cover large expenses, like medical bills, or fund an upcoming event, like a wedding. 

A personal loan is usually given in one lump sum. A home equity line of credit, aka a HELOC, lets you borrow just what you need. You can borrow, repay, and borrow more during the first few years of your loan, which is called the draw period.

Picking the best loan

Whether you’re applying for a home equity loan or a personal loan, it’s a good idea to compare your options. This means researching interest rates, fees, customer service, and reviews. If you have any questions, call the lender’s customer service line and ask them. A loan is a big commitment, and you want to feel comfortable with your decision.