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Secured vs. unsecured loans: what’s the difference?

Looking for a loan? You may have come across the terms ‘secured’ and ‘unsecured’. Find out what the difference is and which one’s right for you.

16 March 2022Lloyd Smith 6 min read
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Amanda Vick

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Getting a loan from a bank or financial institution can be just what you need to fulfill your dream of owning a car, purchasing a house, or even starting your business. But whether you should opt for a secured loan or get an unsecured loan can be a tough decision.

This article breaks down everything you need to know about secured and unsecured loans.

The primary differentiator between a secured loan and an unsecured loan is whether the loan is backed by security.

Here’s a detailed overview of each type of loan to help you decide between secured loans vs unsecured loans.

What is a secured loan

When you apply for a secured loan, you need to provide the lender with security. This can be an asset that offers some value such as your property, accounts, receivables, or even your business inventory. For certain secured loans such as car loans, the asset you want to purchase using the loan amount itself becomes the collateral.

In the event your financial situation is such that you are unable to carry out timely loan repayments, the lender can encash the security to satisfy the outstanding balance.

Usually, borrowers enjoy a lower interest rate for secured loans as the collateral minimises the risk involved for lenders. When comparing secured loans vs unsecured loans, here are a few things to keep in mind:

  • The type of collateral lender is looking for
  • The interest rate for the loan
  • Whether the interest rate is variable or fixed
  • Whether the lender will charge a prepayment fee if you repay ahead of the agreed schedule
  • Is there a maximum amount of loan you can borrow

Secured loans can be availed for several end uses. The approval process for getting a secured loan sanctioned is usually longer when compared to an unsecured loan. Moreover, lenders may also undertake value assessment and need you to furnish additional documentation.

What is an unsecured loan

You don’t have to furnish any physical asset to borrow an unsecured loan. Such loans are sanctioned based on your business cash flow if you are borrowing it for your business or your credit score if you are borrowing it for yourself.

Compared to secured loans, such loans are usually provided at a higher interest rate since the lender has no collateral to fall back on. That’s why the creditworthiness of the borrower is such an important factor. The absence of collateral also makes unsecured loans a popular choice for customers as lenders cannot exercise any rights over their property.

A secured loan can be availed for different end uses.

Based on the utilisation of the loan amount, it can be broadly classified into:

Secured business loans

This refers to loans you can avail of to meet a number of funding needs of your business, such as purchasing new equipment or machinery, expanding your business, purchasing new office space, or purchasing raw materials. The collateral for such loans may vary -- it can be real property, receivables, government securities, or even fixed deposits and savings accounts.

Depending on the loan amount, a lender may even insist on personal guarantees from the business owner.

Secured personal loans

These are loans you can avail of for your personal use. The asset you intend to purchase using the loan amount often becomes the collateral for such secured personal loans.

A secured personal loan can be of different types, such as:

Car loan

A car loan or an auto loan involves borrowing a sum of money to fund the purchase of a vehicle. The loan is secured with the vehicle itself. So in case the financial situation of the borrower deteriorates, and there is a payment default, the lender can seize the vehicle and sell it to meet the outstanding debt.

Interest rates of car loans are usually decided using simple interest. In other words, the borrower repays the loan amount along with a flat percentage of the borrowed amount. Secured car loans are also amortised which means the early payments of the loan factor in interest rates.

Bear in mind that while some banks may also extend an unsecured car loan, significantly higher interest rates of such loans might make it commercially unviable to borrow. Therefore, it may be better to opt for secured car loans.

Mortgage loan

A mortgage loan is a type of secured loan that a borrower can avail by mortgaging an immovable asset with the lender. These loans are available to buy homes or any other real estate. In most cases, the property to be purchased itself becomes the security for the loan.

The interest rates vary depending on the type of property and the ability of the borrower to repay the loan.

Savings-secured loans

Instead of a physical asset, these loans are secured by the amounts you hold in a savings account or through certificates of deposit. They are popular due to their low-interest rates and provide an ability to the borrower to borrow against amounts already available instead of spending it in a single shot. Moreover, you can continue to earn interest on the savings while you repay the loan.

These secured loans allow you to borrow the same amount that you have in your savings account or savings certificate. For example, if you have $6000 in your savings account, you are eligible to borrow a $6000 loan.

Life insurance loans

This is a type of secured personal loan that allows you to borrow against your life insurance policy. The value of your insurance policy acts as collateral. While you have the option to repay the loan in installments during your lifetime, the outstanding loan amount can be deducted from the insurance amount due to your beneficiaries once you pass away.

A bank or a financial institution holding a valid Australian credit license can disburse all types of secured loans.

Similar to secured loans, there are various types of unsecured loans based on their utilisation, such as:

Unsecured personal loan

Unsecured personal loans can be borrowed to fund the personal needs of an individual. There are personal loans available to meet wedding expenses or take a vacation or undertake home renovations.

Unsecured business loan

Unsecured business loans are availed for funding the needs of a business without pledging any collateral. The loans are disbursed by banks or financial institutions after evaluating the cash flow of the borrower.

Such unsecured loans can be further classified into the following categories based on their tenure and repayment structure. These include:

Revolving loans

One of the most common unsecured loans is a revolving credit facility. This allows borrowers to borrow an amount, utilise it, repay it and start withdrawals again. There is a credit limit assigned for such unsecured loans making it easy for the borrower to borrow as many times as needed provided the limit is not breached. The flexibility of borrowing is one of the key reasons why such a loan facility is attractive for borrowers.

These types of unsecured loans are perfect to meet the working capital requirements of a business. The borrower doesn’t have to repay following a strict repayment schedule and the interest rates are also variable.

Term loans

Unsecured loans with a fixed rate of interest and tenure are known as term loans. Borrowers can either opt for short-term loans to meet any immediate funding needs of their business or go for intermediate or long-term loans for lump-sum funding.

Consolidation loans

Sometimes a borrower may find it challenging to repay multiple loans. In such cases, they can opt for a consolidation loan to repay the outstanding amounts of all the accumulated loans.

Banks or financial institutions with a valid Australian credit license can extend unsecured loans.

When you are in the market to borrow money, you need to pick between a secured or unsecured loan. So how do you differentiate between secured and unsecured loans? Here’s what you need to keep in mind:

Collateral: The biggest difference between secured vs unsecured loans is the absence of collateral or security.

Unsecured loans, as the name suggests, don’t require borrowers to provide any security against the amounts borrowed. Unsecured personal loans are sanctioned on the basis of the creditworthiness of the borrower, and unsecured business loans are sanctioned by evaluating cash flows.

On the other hand, lenders extend secured loans such as car loans on the condition that the asset itself acts as a security. If the borrower fails to repay the debt on time, the lender can acquire ownership of the asset and realise the debt.

Rate of interest: A key difference between secured and unsecured loans is their interest rate. When compared to unsecured loans, secured loans tend to have a lower rate of interest as lenders can fall back on the security in case of payment defaults.

Repayment period: Between secured vs unsecured loans, the repayment period of the former is comparatively longer.

Loan amount: The loan amount varies between secured and unsecured loans. The borrowing limits for unsecured loans are lower than secured loans due to the absence of collateral.

Lender’s risk: Lastly, between secured vs unsecured loans, the banks run a higher risk when they disburse unsecured loans since there is no protection offered by the collateral.

To sum up, secured and unsecured loans are the two major financing methods available in the market.

Since unsecured business or personal loans are not backed by any security, your creditworthiness is crucial to obtain a loan on favourable terms. The best way to determine your creditworthiness is by looking at your credit score. With ClearScore, you can access a free credit report and know what to expect when you approach a lender.

Key Highlights

  1. Secured loans require something as collateral, such as your home or your car. Your lender can take this away to pay your debt if you fail to keep up with repayments.
  2. Unsecured loans don’t require collateral - your lender trusts you to repay on time.
  3. Secured loans usually have lower interest rates and are easier to qualify for, but they involve more formalities. They’re also more risky, because your lender has a legal right to take your collateral away if you don’t repay on time.
  4. Unsecured loans are less risky and involve fewer formalities. But they tend to have higher interest rates and stricter approval criteria, which means you’re less likely to be approved or get good terms if you have a lower credit score.

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Written by Lloyd Smith

General Manager AU

Lloyd spreads the word about how awesome ClearScore is.