What are the Main Advantages of a Secured and Unsecured Loan?

Buying a big house in India is still a distant dream for many.

Scores of people still dream of owning a car even after working for decades.

More people brew innovative business ideas that are able to manifest them.

A child’s education abroad (or in premier national institutes) is still expensive for middle-class parents. 

Countless instances such as the ones specified above remain in the realms of wishful thinking, plans, and dreams, never seeing the light of day. And if we are to find that one, almost obvious culprit, behind so many unfulfilled aspirations, then it has to be funds or cash. 

Funds seem to come in the way of dreams and living them in reality. But loans have come to the rescue since the birth of modern money, at times of financial uncertainty, shortage, and insufficiency. When it comes to loans, especially the high-ticket ones (car loans, home loans), you’ve got to decide between obtaining a secured, or unsecured loan. 

Once you’re done choosing between them, the final steps involve checking your eligibility for the loan, gathering documents, filling out the forms, and finally applying for it. But what are secured and unsecured loans? 

Let’s check out the basics, advantages, and other things about secured and unsecured loans.

What is a Secured loan?

Loans or credits obtained from banks and other NBFCs are primarily of two types: secured and unsecured. 

Lenders offer secured loans in exchange for collateral security. It means you’re essentially pledging a certain thing as “collateral security” (in any form of an asset like land and buildings, gold, etc.) as the bank’s safety measures.

If the borrower fails to pay the loan, the bank uses collateral security to recover the debt. Such loans often include mortgages and car loans. 

The bank files negative credit reports (also called NPAs or non-performing assets) if the borrower fails to pay the amount. This act by the bank affects the borrower’s credit score (CIBIL) and the overall image of the borrower, effectively preventing that person from borrowing loans in the future. 

The interest rate is lower for secured loans, and the borrowing limit is often high.

What are Unsecured Loans?

If secured loans require collateral to get sanctioned, then unsecured loans are just the opposite. Banks offer unsecured loans without collateral security. Your credit score and income must be high for an unsecured loan. High creditworthiness helps sanction unsecured loans easily. 

Unsecured loans are risky for both lenders and borrowers. If borrowers fail to repay the amount, then the lender can take legal action. However, lenders can’t take property automatically for recovery.

In unsecured loans, the interest rate is high and the borrowing is restricted to smaller amounts. 

Characteristics of Secured and Unsecured Loans

Both secured and unsecured loans have specific characteristics. They are as follows: 

SECURED LOAN CHARACTERISTICS

For lenders:

• Less risk due to collateral security
• The lender technically owns the borrower’s collateral until the loan recovers
• The lender has the right to collateral for recovery of the loan amount
• A lender decides the loan amount 
• Lenders can file positive/negative credit scores against the borrowers

For borrowers:

• Collateral increases the risk
• High-borrowing limits
• Low-interest rates
• Long repayment time
• Poor people can easily apply

UNSECURED LOAN CHARACTERISTICS

For lenders:

• No collateral brings more risk
• Lenders can’t seize property by default to recover the loans
• Lenders can only take legal action
• Lenders set loan amounts and interest rates as per their wish

For borrowers:

• Less risky
• Income and credit scores must be high
• High interest and fewer amounts
• Strict eligibility to pass

Advantages of Secured and Unsecured Loan

Banks offer secured and unsecured loans, which have a number of advantages. These advantages may benefit one but not the other. This is why it is advisable to carefully read and compare the characteristics before choosing between secured and unsecured loans:

Secured loan advantages

High loan amount accessibility

In a secured loan, the borrowing amount is higher than in an unsecured loan. A large loan amount can solve many problems for the borrower. 

The collateral values 85-95% of the loan amount. You can apply for a higher loan amount with your valuable collateral security. The collateral security brings trust to the lender.

 If the borrower fails to pay, collateral security is there for recovery.

Has low-interest rates

The high-value collateral security gives lower interest rates to the borrower. The security brings relief to lenders in regard to recovery and hence allows them to charge less interest on the loan. 

A high credit score is optional for such loans. Income is also not a concern for a secured loan. 

Keep the legal papers updated if you’re applying for a loan with land as collateral. Updated documents help in the quick sanctioning of loans. It increases the credit score as well. 

Does not require a high credit score

A high credit score is not an issue in the secured loan application. The income statement is also not necessary.  

Poor or middle-class people with low or mediocre incomes can apply with collateral. 

Helps build creditworthiness

You can increase your credit score with a secured loan. All you need to do is pay the repayment amount (interest plus principal) on time. 

Timely repayment reflects a positive image of the borrower. The bank files a positive image and expands its credit score. 

 A high credit score increases credibility for future business and personal loan eligibility. 

Gives longer tenure for repayment

You can pay the repayment on time to increase the tenure. The bank may divide the amount into small intervals upon trusting the borrower with timely repayments. It is easy for the borrower to pay a small amount monthly.

You can negotiate the debt repayment interval and amount with the bank.

Unsecured loan advantages

Fast disbursal

Banks sanction unsecured loans quickly as they don’t need collateral. An unsecured loan eliminates the lengthy documents as it doesn’t need collateral. 

You can easily apply for a loan without collateral. Only a high credit score can get you a fast loan disbursal. 

Flexibility

You can apply for an unsecured loan and choose a mode of repayment. Borrowers can pay the repayment amount once without penalties. You can draw the amount of your choice whenever you want. 

The bank charges interest on the amount only used at present. It gives access to the borrower to close the whole loan in 6 months.

Does not pose assets risk

If the borrower fails to repay on time, the asset will not be at risk when it comes to an unsecured loan. The lender can’t seize the collateral automatically. You can apply for more time and answer the lender legally. 

Helps manage cash flow

Unsecured loans help with money in critical situations. It helps in the investment and purchase of assets in a growing business. 

Increases your credit score

You should always pay the repayment amount on time. It helps increase the credit score through the bank.  

It builds your creditworthiness for the future. It makes you eligible for a high amount of loan approval for further needs.

Takeaways

As you have just seen, there are various advantages to both secured and unsecured loans. Collateral security is the only difference between secured and unsecured loans. 

Middle-class borrowers can apply for a secured loan. This is because it needs no credit score or valuable collateral. People with high credit scores can easily get a secured loan. 

Read about the advantages and characteristics of secured and unsecured loans. 

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