- Unsecured personal loans and credit cards don't require any collateral.
- Secured loans, like a mortgage or auto loan, require you to pledge an asset as collateral.
- Before you borrow money, take time to explore both secured and unsecured options.
Consumers who need to borrow money have a wide range of loan options to consider. However, all loans, lines of credit, and other financing methods fall into one of two categories — unsecured or secured debts.
While both secured and unsecured loans and lines of credit could help you reach your goals, one main factor sets them apart. Where secured loans require collateral, unsecured financing methods don't require any collateral at all.
What is an unsecured loan?
Definition of an unsecured loan
Unsecured loans and financial products can come in many different forms, but the underlying premise and agreement are the same. Consumers are not required to put down any of their assets to obtain an unsecured loan, but they do have to agree to repay the money they borrow — plus interest, of course.
Without any collateral requirement at the beginning of the loan, unsecured debts have more stringent requirements to qualify. The best personal loan rates you may have access to depend on your credit score. You typically need good or excellent credit to qualify for unsecured loans with the lowest interest rates and most favorable loan terms. You also need to be able to illustrate your ability to repay and be able to prove you have a reasonable amount of liabilities compared to your income.
Types of unsecured debt
Unsecured debt can come in many forms, the most common being:
- Unsecured credit cards (the vast majority of credit cards)
- Most personal loans
- Student loans
Other debts that are considered unsecured include telephone and electric bills (and other utilities), court judgments, and even medical bills.
What is a secured loan?
Definition of a secured loan
Secured debts are any type of debt that is held with an underlying form of collateral. This could be a cash deposit you put down, an automobile, your home, stock you own, or any other asset that has significant value.
Secured debts are typically considered lower-risk for the lender since it has an asset to seize in the event the borrower stops making payments. For that reason, secured debts often have lower interest rates than unsecured alternatives.
Types of secured debt
Secured loans and lines of credit can work very differently depending on the type of secured debt you're dealing with. The most common types include:
- Secured credit cards
- Secured personal loans
- Home equity loans
- Home Equity Lines of Credit (HELOCs)
- Auto loans
- Mortgages
Unsecured loans vs. secured loans: key differences
| Unsecured loans | Secured loans | |
| Collateral required? | No | Yes |
| Credit check? | Yes | Yes, but may be able to get one with worse credit history |
| Approval requirements? | Tighter | Looser |
| Speed of application process? | Fast | Sometimes slow |
| Failure to repay? | Lender can't seize your assets | Lender may be able to seize your assets |
Before you borrow money, take out a line of credit, or apply for a credit card, make sure you know the difference between secured and unsecured debts. While either can help you reach your goals, the presence or absence of collateral is an important consideration that should be decided ahead of time.
Whatever you do, take the time to compare loan options and read the fine print before you sign on the dotted line for any type of loan. If there are any unsavory terms and conditions to be found, they will be tucked away in the fine print.
How to qualify for an unsecured loan
Getting approved for an unsecured loan can be more difficult than a loan backed by collateral.
Credit score requirements
Since the lender is assessing the risk of lending to you based exclusively on your creditworthiness, your credit score will play a big part in whether you're qualified to borrow as well as the interest rate you'll pay, the amount you can borrow, and the term of the loan if you're approved.
Most lenders like to see a credit score in the mid-600s. The higher your credit score, the less you're overall cost of borrowing will be.
Income and debt considerations
Other key factors affecting your application for a loan include your income and employment history, debt-to-income ratio (DTI), the amount you want to borrow, and how long you want to take to repay it. Experts recommend a DTI ratio of 36% or less for personal loans. If your DTI ratio is higher, you may consider increasing your income or paying off existing debts before applying for an unsecured loan.
Pros and cons of unsecured loans
Advantages of unsecured loans and lines of credit
- When you apply for an unsecured loan or credit card, you won't have to put down a cash deposit as collateral.
- If you default on an unsecured debt, the bank won't be able to seize your assets.
- The application process is usually quick and painless. You can apply for unsecured personal loans and credit cards online and from the comfort of your home.
Disadvantages of unsecured loans and lines of credit
- While the bank cannot seize your assets if you default on an unsecured debt, they can try to obtain a judgment against you. Defaulting on your loan will also result in severe damage to your credit score that may be difficult to overcome.
- Requirements for approval are tighter. You need good or excellent credit (usually a FICO score of 740+) and a solid work history to qualify for the best unsecured loans and credit cards. You may be able to qualify for some unsecured loans with fair credit, but you'll typically pay a higher interest rate and more fees.
- Interest rates tend to be higher on unsecured debts when compared to some types of secured debts.
Alternatives to unsecured loans
It's important to weigh your options and make sure you completely understand what is available before signing a loan agreement.
If your credit history isn't great or you're simply looking for other financing options, here are some common alternatives to unsecured personal loans that may work for you:
- Secured loans
- Credit cards
- 0% APR credit cards
- Home equity line of credit (HELOC)
- Personal line of credit
Frequently asked questions about unsecured loans
Can unsecured loans be used for any purpose?
Unsecured personal loans usually don't come with restrictions on their use, allowing borrowers to use the funds for various purposes. In some instances, like with debt consolidation loans, a lender may require that you use the proceeds exclusively for that stated purpose.
Are interest rates on unsecured loans higher than secured loans?
Unsecured loans usually have higher interest rates compared to secured loans because the lack of collateral increases the lender's risk. The lender offsets this by charging a higher interest rate.
What happens if I default on an unsecured loan?
Defaulting on any loan has serious consequences, including damage to your credit score and potential legal action. While lenders can't seize collateral with a secured loan as there is none, they can pursue other collection actions.
How does my credit score affect my ability to get an unsecured loan?
Loan eligibility requirements vary based on the lender, but generally, the higher your credit score, the more likely you are to qualify for an unsecured loan. If you don't have the best credit score, some lenders will still give you a loan but may charge more interest.
