Secured vs. Unsecured Loans
Before choosing a secured or unsecured loan, a borrower must know the fundamental difference between the two options. Secured loans, which are the more traditional type of loan, use a borrower's assets as collateral for the money borrowed. If the borrower defaults on the loan, that is he/she fails to pay, the lender can claim the collateral. Cars, homes, and other real estate are the most common forms of collateral. An unsecured loan does not require collateral.
Interest rates are a reflection of the amount of risk that a borrower poses to a lender. Secured loans, due to their collateral requirement, are less risky than unsecured loans. In the case of default, with a secured loan, the lender will lose money, but will obtain a concrete asset in the money's place. With unsecured loans, a lender completely loses out if a borrower defaults. If the lender does not receive money, the lender does not receive anything. Because risk is higher with unsecured loans, the interest rates of unsecured loans are higher than those of secured loans.
It is easier for a borrower who has bad credit to obtain a secured loan than it is for him or her to obtain an unsecured loan. Lenders that have collateral from a borrower are not as concerned with credit history because, if the borrower defaults, the lender receives the collateral. Lenders that do not have collateral from a borrower are concerned with the credit history of the borrower because, if the borrower defaults, the lender loses out. A person with bad credit history is more likely to default and therefore is a higher risk to the lender.
Making the Choice
If a borrower is completely confident of his/her ability to pay the interest and principal on a loan, and if that borrower owns assets to put forward as collateral, then he/she should opt for a secured loan. If a borrower is unsure of his/her likelihood to default, then that borrower should choose an unsecured loan. If a borrower's assets are irreplaceable or one of a kind, then an unsecured loan may be the safer option.