Secured and Unsecured Borrowing Explained

No great things can be reached without taking some level of risk. However, that does not mean that we cannot strive to minimize these risks as much as possible. When you find yourself in need of a large amount of money, you are presented with a variety of options for obtaining it. One of those options is taking out a loan.

When exploring loan options, you will see that you have the option of going for secured or unsecured loans. Both of these categories have their advantages and disadvantages and which one you should get will heavily depend on your particular situation. This is why you need to inform yourself thoroughly about the differences between these two categories and what each of them entails. Here is what you need to know about secured and unsecured borrowing.

What is a secured loan?

When you’re taking out a secured loan, you will need to present a piece of collateral, which is a valuable possession of yours, such as a house or a car. In case we’re talking about a business, business assets can be collaterals, too. It’s a layer of protection for your lender in case you are unable to repay the money. Since they can take possession of your collateral in that case, your lender can rest assured that their funds are safe.

What is an unsecured loan?

As opposed to secured loans, unsecured loans do not require a piece of collateral in order to make the deal. It’s a riskier agreement for your lender since they won’t have a secured asset that assures them that their funds are safe. Naturally, this means that there will be some disadvantages to unsecured loans for those who are borrowing.

Advantages and disadvantages of secured loans

While the terms of a secured loan may seem more favorable, there are a few pros and cons you need to weigh before making your decision. One of the main advantages of secured loans is that they are easier to obtain. Since your lender takes a smaller risk thanks to your collateral, you are more likely to qualify even if your credit score is less than perfect. This makes secured loans a viable option for those who are looking to fund a business venture but do not boast a great credit history.

Another important advantage that makes secured loans a favorable option is that they usually involve better interest rates. This means that if you’re confident that you can pay off your loan in a timely manner and your collateral is not going to be threatened, then taking out a secured loan is a smarter decision cost-wise. In addition, secured loans usually have higher limits when it comes to the amount borrowed, which means that if you’re in need of a large sum of money, this is the way to go. However, while secured loans may have better terms, do not forget that you will be putting a valuable possession on the line. This makes secured loans riskier. Should something go awry, you may lose important assets.

Advantages and disadvantages of unsecured loans

The pros and cons of unsecured loans are quite complex. While one of the main advantages is that you do not need to offer a valuable personal asset to obtain the money you need, rest assured, that does not mean that you are safe. Since this type of loan has a higher risk for the lender, unsecured loans are going to have stricter limits when it comes to the amount borrowed. Similarly, interest rates tend to be higher in the case of this type of loan. Since there is no collateral in the equation, if you are unable to keep up with the payment, your debt can pile up considerably due to the interest rates. To prevent this from happening, it is important that you prioritize paying off unsecured loans, even before secured ones. That said, unsecured loans are a good option for borrowing smaller amounts of money, and the fact that you don’t need to secure an asset can be a great advantage for businesses that simply cannot, for instance.

Unsecured loans as a short-term solution are also a great option for businesses that need a boost to their cash flow during slower periods. In addition, despite the high interest rates, remember that credit score plays a more important role in the case of unsecured loans, so if your credit history is great, you may be able to get lower interest rates from your lender. Some lenders may also offer more flexibility when it comes to repayment terms.

As you can see, neither secured nor unsecured loans are ideal, but taking the pros and cons into account, it is quite clear which one makes better financial sense in a particular situation. Consulting professionals before making a decision is still recommended since everyone’s financial situation is different.