You have a financial situation but don’t have the cash to cover it. It happens. So, you need a loan. However, do you want a secured or unsecured loan? After all, there are key differences between the two you must understand before seeking a potential lender. For example, what you need for a title loan differs in notable ways from requirements for a personal loan, which is largely based on your creditworthiness. For clarity, here’s how secured loans differ from unsecured loans.
Secured Loans vs. Unsecured Loans
The primary difference between the two types of loans is that secured loans require collateral, such as your house or vehicle. This affects the loans’ accessibility, terms, and risks.
Secured Loans
These loans are backed by collateral, which your lender can claim if you don’t repay according to your loan agreement. Compared to unsecured loans, secured loans typically offer higher borrowing limits and lower interest rates. They’re also easier to get because they don’t pose as much risk for the lender. Auto loans, car title loans, and mortgages are examples of secured loans.
Unsecured Loans
No collateral is required for unsecured loans. Lender approval is based on your credit standing and ability to repay. These loans generally have lower borrowing limits and higher interest rates. They’re also relatively harder to get. Prime examples of unsecured loans are student loans, personal loans, and credit cards.
Pros and Cons
Secured Loans
On the plus side, secured loans generally offer lower interest rates and higher borrowing limits, as well as easier approval for those with weaker credit ratings. A drawback is the potential loss of the asset put up for collateral if you default.
Unsecured Loans
Benefits include a potentially faster loan approval process and no risk of losing your personal property. On the downside, you may face more stringent credit requirements and higher interest rates. You may also have lower borrowing limits.
How to Qualify for a Secured Loan
To qualify for a secured loan, you’ll typically need to:
Provide acceptable collateral. You’ll need to put up an asset of value — a vehicle or house, for example. What’s acceptable is up to the lender and the amount you’re seeking.
Meet Credit and Income Requirements
Because they’re attached to collateral, secured loans can be easier to get. However, lenders may still consider your credit score and ability to repay. Typically, good credit is not what you need for a title loan, although the lender might run a check. Title lenders are generally more concerned about the value of the vehicle you put up as collateral, as well as your loan repayment ability.
Verify Income
You’ll typically need to show pay stubs, bank statements, or tax returns to prove that you can make regular payments. Lenders also commonly check your employment history.
Submit Required Documentation
You’ll typically need to provide documents verifying your identity, collateral ownership, and income. A collateral appraisal may also be necessary.
How to Qualify for an Unsecured Loan
To obtain this type of loan, lenders will typically consider your:
Credit Score
Lenders typically require a credit score of at least 580, although some set the threshold at 670 and above. The highest scores usually get the best rates.
Credit History
Lenders typically want to see that you have a history of on-time payments — at least two years of history is usually required — plus a mix of account types.
Income
You must show that you have the income to be able to handle your loan payments. You’ll also need proof of income. Income requirements vary by lender.
Debt-to-Income Ratio
Lenders will usually assess this ratio to make sure you aren’t overextended. Many prefer a DTI of under 36%, though some will accept as high as 43%.
When it Comes to Loan Types, Knowledge is Power
What you should mainly remember is that secured loans are backed by collateral and usually have better terms. However, you must be certain you’re able to repay the loan as contractually required, or risk losing your collateral to the lender.
On the other hand, unsecured loans are primarily based on your credit, in addition to repayment ability. They typically have stricter approval requirements and carry higher costs.
When it comes to borrowing, choose wisely in accordance with your financial situation.
