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If you’re thinking about applying for a personal loan, you should first understand the difference between secured and unsecured personal loans.
The difference could affect how likely you are to get approved for a personal loan, the interest rate you’ll get, and whether you’ll have to risk some property to get the loan. Let’s look at how both work as well as some things you should know in order to decide which type of personal loan is right for you.
What are secured and unsecured personal loans?
Loans, including personal loans, typically come in two “flavors” — secured or unsecured.
To get a secured loan, you offer something you own as collateral. You agree that if you default on the loan, your lender gets to take the collateral. In the case of a mortgage or auto loan, your house or car is typically the collateral. In the case of a secured personal loan, the collateral might be money in a savings account or a certificate of deposit.
An unsecured personal loan doesn’t require you to put up any collateral for the loan. If you don’t repay it, the lender can’t claim collateral as compensation. But there is something you risk if you default on either unsecured or secured loans — your credit. Lower credit scores could make it more difficult to get approved for other types of credit.Find out what happens when you default on a loan
Interest rates: secured vs. unsecured personal loans
Unsecured personal loans typically have higher interest rates than secured loans. That’s because lenders often view unsecured loans as riskier. Without collateral, the lender may worry you’re less likely to repay the loan as agreed. Higher risk for your lender generally means a higher rate for you.
Personal loans are generally unsecured. As of May 2018, the average APR, or annual percentage rate, for a 24-month personal loan was 10.31%, according to Federal Reserve data.
A secured loan typically would have a lower rate. For example, Los Angeles residents may be able to qualify for a Wells Fargo personal loan of $25,000 with a possible APR of 5.61% for 60 months if the loan were secured with a CD or savings account.
Sources for secured and unsecured personal loans
Three types of lenders that offer personal loans.
- Credit unions
- Online loan companies
Of course, lenders can vary widely in their loan-qualification requirements and the interest rates they’ll offer. But banks often prefer to lend to consumers with higher credit scores. Credit unions may be less strict in their requirements when making loans and may be able to offer lower interest rates, but you’ll need to be a member in order to qualify.
Online lenders may offer lower rates for applicants with good credit. And they can be convenient, because the entire loan process is typically handled online. But an online lender may be unable to issue a loan in your state.
Which type of personal loan is best for you?
To figure out which type of lender and loan is best for your needs, shop around, apply for prequalification for a few loans, and compare the offers you receive from different lenders. Rates and terms can vary substantially, so shopping around could help you find a lower interest rate or fees, and save you money to help you pay off your loan sooner.
If you have a savings account, CD or other asset that your lender will accept as collateral, you might want to apply for a secured loan, because your interest rate and APR would likely be lower.
If you don’t have an asset that your lender will accept, or you’re not willing to risk losing an asset that you have, you can apply for an unsecured loan.
Qualifying for a personal loan
There’s no one specific step-by-step way to qualify for a personal loan. That’s because every lender has somewhat different requirements, and every borrower’s personal situation is somewhat different.
That said, there are some basics you can expect. Most lenders will check your credit history and credit scores, review your income, and consider how much debt you already have before they approve your loan. One key question the lender is likely to investigate is whether you earn enough income to afford the payments you have to make each month. If you apply for an unsecured loan, your credit, income and current debt will likely receive more scrutiny, because there’s no collateral to back your loan.
If you apply for a secured loan, the lender will want to feel confident about your collateral, its value and the fact that you own it outright.
Many lenders offer an online prequalification process. For example, you can apply for prequalification for personal loans with lenders such as LendingClub, SoFi and Best Egg through Credit Karma.
Polish your credit before applying
Since your credit is a major factor in whether you’ll be approved for a personal loan, and if so, what rate you’ll be charged, it’s smart to review your credit reports and scores before you apply.
If your credit isn’t very good, there are strategies you can use to help improve your credit to qualify for the loan you want.
Here are four tips.
- Check your credit reports and credit scores to find out where you stand. It’s important to check your reports as well as your scores. Some of the information contained in your credit reports is used to calculate your credit scores.
- Improve your credit health. You can work on strengthening your credit by making all of your payments on time, using no more than 30% of the credit you have available, keeping your oldest credit accounts open, and opening new accounts only when you need and can afford to utilize more credit.
- Apply with a co-signer who has good credit. If you’re applying for an unsecured loan and your credit isn’t great, a co-signer who has healthy credit might help you get approved and secure a better loan rate.
- Avoid expensive, high-risk debt.
Loans that have short terms, high interest rates and high fees can set you up for credit problems if you’re not able to repay the debt. Asking a friend or family member to lend you the money you need might be a smarter option.
Both secured and unsecured personal loans have unique advantages and disadvantages. On one hand, a secured loan may come with a lower APR, but are you prepared to risk the property you’ll have to put up as collateral? And though defaulting on either unsecured or secured loans might mean your credit takes a hit, you’ll avoid putting up any property as collateral with an unsecured loan (but be prepared to pay higher rates than you might on a secured loan).
If you’re still not sure whether a secured or unsecured personal loan makes sense for your situation, you might want to talk to several lenders and find out whether you’re qualified. Ask potential lenders about their rates and APRs, as well as maximum loan amounts for secured and unsecured loans. Getting more information should help you figure out which loan offer you want to apply for — if any of them.
And if you decide to wait and work on building your credit instead, here are some more tips to get you going:5 quick tips to improve your credit health