Difference Between Secured And Unsecured Loans?

The two most common types of loans people take out are personal and business loans. They are both intended for different purposes, have different borrowing limits, and have other associated terms and conditions, one of the chief ones being secured or unsecured. Let us examine their definitions and critical differences between secured and unsecured loans.

What is a Secured Loan?

As the name suggests, secured loans are provided by banks and non-banking financial companies (NBFC) instead of some collateral that the borrower needs to put up as security. 

This collateral can be a new item purchased, with ownership rights in the lender's name, until the amount is repaid, such as a car, house, or shop. In other cases, it could be an existing security owned by the lender. These securities can be shares, stocks, gold, property, etc.

Several financial institutions have many such secured business loan products available in their portfolio, such as home equity lines of credit, loans against property, loans against securities, and gold loans.

Secured business loans are the most common method of availing business loans. This is because, typically, larger sums need to be borrowed, which requires the lending institution to safeguard its interests by requiring the borrower to put up collateral. 

These also involved longer repayment terms and competitive interest rates. Be cautious; a secured loan entails that in case of defaulting in payment or reneging from the repayment contract, the lender will have the right to sell off the collateral to compensate for their losses.

What is an Unsecured Loan?

Unlike secured loans, unsecured loans do not require collateral or security on the borrower's part. From a lender's perspective, these loans are riskier regarding repayment and the credit risk of defaulting. 

Unsecured business and other unsecured loans come with higher interest rates and shorter repayment tenures to offset this risk. The borrowing limits are also lower, as lenders wish to lend large amounts only after receiving security in return as assurance. 

However, it is different from lenders unquestioningly providing unsecured loans. Certain factors come into play during the borrowers' financial assessment, such as the credit score, risk profile, past track record, payment history, current income, existing debts, etc. 

The borrowing limit, interest rate, and repayment tenure are locked based on a combination of these factors. Some typical examples of commonly occurring unsecured loans are credit cards, personal loans, and student loans.

In Summation

To summarize what we have discussed above, the critical difference between an unsecured and a secured loan is the requirement of collateral for securing the loan. In the case of secured loans, some sort of tangible collateral needs to be temporarily owned by the lender. This is why most business loans are secured loans.

Due to the assurance with the lender, collateral allows for higher borrowing limits, better rates, and longer repayment terms. In case of non-repayment, the lender has the right to liquidate the security or collateral and balance the originally lent amount.

Business loans may also be taken as secured loans, but the amount might be low and the interest rate high. Overall, there are better options than this. On the other hand, personal loans are frequently unsecured and offered based on the borrower's credit rating and financial history.

Due to the reasons above, secured loans are easier to obtain and offer more benefits to the borrower; however, this largely depends on your individual needs and requirements. It also depends on your ability and willingness to put up collateral in return for the loan. In the case of smaller amounts intended for personal use, unsecured loans might be more apt.

Visit your preferred lender's website to compare the terms and rates before deciding.