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What is a secured and unsecured loan?

Mark Bristow avatar
Mark Bristow
- 4 min read
What is a secured and unsecured loan?

A personal loan is a simple way to borrow money to pay for a major purchase, or to cover the costs of a personal project. When you apply for a personal loan, you may be able to choose between a secured loan and an unsecured loan. A secured personal loan uses an asset, such as a car, as security. In contrast, an unsecured personal loan doesn’t require any collateral or assets to secure it.

How do secured personal loans work?

You may be able to secure a personal loan with a new asset you may be buying, such as a car, or an asset that you already possess, such as home equity. 

Lenders can be flexible about the assets that you can use as security for a secured personal loan. Some of the acceptable assets may include:

If you default on a secured personal loan, note that the lender will repossess the mortgaged asset to recover the loss. Because this lowers the lender’s financial risk, secured loans often offer lower interest rates compared to unsecured loans. 

On the other hand, lenders may restrict how you can use the money borrowed through a secured personal loan, and may also only approve a limited amount. For example, if you are taking a secured loan to buy a car, you can only use the money towards purchasing the car.

How do unsecured personal loans work?

Unsecured personal loans don’t require you to provide collateral, giving them some extra flexibility. But because of the higher financial risk for the lender if you don’t keep up with your repayments, unsecured personal loans often charge higher interest rates and fees, and may have other eligibility criteria around your income, expenses, and credit score.

When you take out an unsecured loan, there is usually no restriction on how you can use the borrowed money. So, if you want a loan to pay for multiple purchases, like a car and some furniture, or to pay for something intangible like a wedding or a holiday, an unsecured loan may be worth consideration.

Should you use a secured or unsecured loan when buying a car?

Securing a personal loan with the value of a car you’re purchasing may help to lower a lender's risk, so you may be offered a lower interest rate. 

However, the age, type, and price of a vehicle may affect your eligibility for a secured car loan. Some financial institutions only accept newer vehicles as security, so if you’re buying a used car, you may not be eligible for a secured loan. Even if lenders accept an older car, they may still have a maximum age limit, such as less than seven years old. Also, the car may require an inspection check before the lender will accept it as a security for a loan. Plus, new cars often have higher price tags than used cars.

Unsecured car loans are often more flexible than secured car loans, so you may be able to use them to buy more affordable used cars or vehicle models that aren’t acceptable for use as security. Just be sure to check your budget to ensure you can afford the repayments, as unsecured loans often charge higher interest rates.

Comparing secured vs. unsecured personal loans

When you’re comparing secured and unsecured personal loans, it’s best to base your decision on your financial situation and requirements.

Lenders may provide fixed or variable rates for both types of personal loans, so your repayments may stay the same or fluctuate with the market. Whatever you choose, your interest rate may be partially based on your credit score. Checking your score for free can give you an idea of how a lender may see you before you apply. 

Many lenders also charge an establishment fee, and some may also charge monthly fees, which may affect a loan’s overall cost. Checking the Comparison Rate can give you a better idea of a personal loan’s total cost. 

Compare the various personal loan options that are available to find the best deal that suits your particular requirements and situation.

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Product database updated 25 Jun, 2024

This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.