Short answer: a secured loan is backed by collateral, something of value such as a car, a boat or a home, that the lender can take to get its money back if you cannot repay. An unsecured loan has no collateral; the lender relies on your credit history instead (CFPB). A secured loan may be easier to get and may cost less, but you put the collateral at risk.
Side by side
| Secured loan | Unsecured loan | |
|---|---|---|
| Backed by | Collateral you own (for example a car, a home or a bank deposit) | Your credit history and income only |
| Easier to get? | May be easier, especially with a low score or a short credit history | Usually needs a stronger credit record |
| Interest rate | May be lower | May be higher, because the lender takes more risk |
| If you do not pay | The lender can take the collateral, and can also report late payments, use debt collection or sue | The lender can report late payments, use debt collection or sue |
Every row above comes from the CFPB guide on secured and unsecured loans (CFPB). Note the last row: in the CFPB's words, "Loss of collateral isn't the only consequence of nonpayment of a secured loan."
What a lower rate is worth: the math
Assumptions: $3,000 borrowed for 24 months, fixed monthly payments, no fees. The rates are examples to show the size of the difference, not offers. The payment uses the standard formula explained in our payment formula guide.
| APR | Monthly payment | Total interest |
|---|---|---|
| 12% | $141.22 | $389.29 |
| 18% | $149.77 | $594.54 |
| 24% | $158.61 | $806.72 |
On these numbers, each 6 points of APR changes the total interest on $3,000 by roughly $200 over two years. That saving is the reason to consider a secured loan. The question is whether it is worth putting the collateral on the line.
What can happen to the collateral
- A car: in many states the lender can take the car as soon as you default, without going to court and without warning you first, as long as it does not "breach the peace" (FTC).
- You can still owe money after it is taken. If the sale does not cover the debt, the gap is a deficiency. The FTC example: you owe $15,000, the car sells for $8,000, and you still owe $7,000 plus fees, and in most states the lender can sue you for it (FTC).
- Household goods: under the FTC Credit Practices Rule, a lender may not take a nonpossessory security interest in your household goods unless the loan is the one that paid for those goods (16 CFR 444.2).
- Payday loans: a payday loan usually is not secured by property, but the lender may ask for a post-dated check or access to your bank account (CFPB). See what to do if you cannot repay a payday loan.
Which one fits
- An unsecured loan fits when you can qualify at a rate you can afford and you do not want to risk losing something you need, like the car you drive to work.
- A secured loan can fit when it is the difference between a reasonable rate and an expensive one, and you are confident you can make every payment.
- If you are already behind on other debts, adding a loan backed by your car or home raises the stakes. Look at when consolidation actually saves money first.
- To build credit rather than borrow cash, a credit builder loan works differently: the lender holds the loan money in a savings account until you finish paying, so there is no car or home at risk.
Before you sign a secured loan
- Read the contract for exactly what is pledged, and whether it covers anything besides the item named.
- Compare the APR on the secured offer with any unsecured offer, using the APR, not the interest rate.
- Ask what happens if you miss one payment: late fees, when default starts, and whether you can catch up.
- Never pay a fee up front to "unlock" a loan, secured or not. That is a scam sign (FTC).
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Disclosure: Modern Lending Solutions is not a lender, loan broker or agent for any lender or loan broker, and does not make credit decisions. Any compensation we receive is paid by participating lenders, only for advertising services. This guide is general information, not financial or legal advice.