When searching for a loan, be it for business or personal use, you will have no doubt encountered two terms along the way – unsecured and secured. These two terms refer to the categories of loans that a borrower can choose between. Both categories are universal. Being offered by banks, credit unions, private lenders, and so on, and each type has its advantages and disadvantages. To make the best decision for your situation, you first must understand the difference between the two.

In this article, we will discuss unsecured loans and secured loans. The differences between the two, and which you should choose.

What are unsecured loans?

Put simply, an unsecured loan is a type of finance that does not require any form of collateral. This means that you will not be expected to use property, vehicles, or any other physical asset in order to obtain an unsecured loan. While this acts as an advantage, lessening the risk for the borrower, it is balanced by increasing the risk assumed by the lender. This risk increase typically means lenders are much more cautious when deciding which loan applications to approve. Unsecured loan lenders also tend to adhere strictly to their lending criteria, offering little room for negotiation.

Also Read: Is a Secured Loan a Good Choice With Bad Credit?

Credit Rating

Unsecured loans do not require the borrower to supply any collateral assets. So, there is a heavy emphasis placed on the credit rating of the loan applicant. Due to the higher risk of unsecured loans, lenders tend to only seriously consider borrowers with a high credit rating and a history of prompt repayments. Lenders will also assess a prospective borrower’s income, weighing it against the value of the loan in question. In some cases, lenders will also seek out referrals from other lenders. Assuming your history as an unsecured borrower is squeaky clean, you should have no trouble obtaining an unsecured loan.

Also Read: Using Invoice Financing For Small Businesses

However, unsecured loans have a notable downside that could rule them out for certain small businesses. As they do not require collateral assets, unsecured loan lenders further mitigate risk by charging considerably expensive interest rates. In doing so, lenders can cushion themselves against potential default by recouping some of their money through high interest rates. While high interest rates are normal for unsecured loans, this is not the case for all of them.

Loans from the government, for example, are often given with fairly cheap interest rates, or other factors that lessen the financial strain. A prime example of this is the government’s Bounce Back Loan Scheme (BBLS). The scheme was implemented in response to the Coronavirus pandemic and its effects on the economy. Although the loan had to be repaid by the companies that received it, the loan was unsecured by the borrower, had low interest rates, and offered several methods for making repayment easier. That being said, cheap unsecured loans are the exception, not the rule.

Also Read: How Long Does It Take To Get a Bridging Loan?

What are secured loans?

Secured loans, as you might expect, are the opposite of unsecured loans. Essentially, this type of loan allows borrowers an easier time obtaining finance at the cost of requiring physical assets to be used as collateral. Generally speaking, any form of asset can be used as collateral. The rule of thumb is the asset matches the loan. For example, if you intend to use your secured loan to purchase property, you will typically be expected to use property as collateral.

This means that borrowers will assume a higher level of risk. These assets can be seized in the event of default. In this case, assets will be seized to recover the remaining balance of the loan. Which could result in all collateral assets being seized, or one of the smallest value. While this certainly does make secured loans a riskier prospect for borrowers, lenders assume less risk when handing out loans, which brings its own benefits.

Also Read: Are Small Business Loans Considered secured or Unsecured?

Collateral assets

When applying for a secured loan, the main point of consideration is the value of collateral assets. The borrower will have to ensure these assets are kept in good repair. Providing evidence of regular maintenance and that the asset is in working order. Additionally, the borrower must supply evidence of the value of collateral assets. The best way to do so is in commissioning a survey from a third-party valuer. Who can professionally assess the asset to provide a reliable estimate of value. This valuation can then be passed on to a lender as evidence. If the asset or assets being used as collateral match the value of the loan being sought, it is likely that the application will be successful.

While the value and condition of collateral assets are the most important factors for a secured loan, they are not the only ones. Lenders will also require borrowers to take out insurance that protects collateral assets, ensuring the value remains protected. This ensures that, in the case of an accident such as a fire, lenders will not be stuck with an asset of low value. Instead, the insurance providers will make up the remaining balance of the loan if necessary. In addition to insurance, secured loan lenders will still want to see the credit rating of a prospective borrower. While this is not as important as it is for an unsecured loan, having a poor credit history may result in you having to pay a higher interest rate or other fees.

Wrapping up

Both types of finance can be perfectly viable for any use, though they do have their advantages and disadvantages. Unsecured loans are difficult to obtain with a poor credit rating and are expensive, but are quite low-risk for borrowers. On the other hand, secured loans are the opposite. They are typically easier to obtain regardless of credit rating and are cheaper. However, they also bring higher risk to the borrower. While this risk can be unremarkable if you know you can repay the loan, it can spell disaster for borrowers that encounter unexpected financial problems. As such, you should take great care when using this category of loan, and thoroughly research your options before doing so.