Loans can be a helpful tool for meeting both pre-planned and urgent financial requirements, especially if you are a small business owner. However, there are so many different types of loans, each with its own features and advantages. Therefore, it is crucial to understand the type of loan thoroughly before applying.
Two of the most popular categories are secured and unsecured loans. In this article, we will explore the differences between these two types of loans. Additionally, we will also look at whether secured or unsecured loan options are the smarter borrowing choices for you.
What is a Secured Loan?
A secured loan is a credit facility offered by banks and non-banking financial companies (NBFCs) that is backed by an asset. To avail of a secured loan, you must have an asset to use as collateral. The collateral can be your property, car, gold, fixed deposits, or any other asset of value.
If you default on loan repayments, the lender has the legal right to seize the collateral and sell it to recover their money. Home loans, vehicle loans and loans against property (LAP) are some of the most common examples of secured loans. As a matter of fact, some lenders even offer secured personal loans as well.
What is an Unsecured Loan?
An unsecured loan is a credit facility offered by banks and non-banking financial companies (NBFCs) without any collateral. As there is no requirement for collateral to secure the loan, the lender often takes on higher risk.
In the case of default, recovering the loan amount from the borrower becomes more challenging for the lender. Personal loans are a classic example of unsecured loans. Other common examples include student loans and credit card loans.
Key Differences Between Secured and Unsecured Loans
Now that you have been briefly introduced to the concept of secured and unsecured loans, let us now delve into the various differences between these credit facilities in detail.
- Collateral Requirement
The primary difference between secured and unsecured loan options is the collateral. Secured loans require you to pledge an asset you own as collateral to get funding. On the other hand, no collateral is required for availing of unsecured loans from lending institutions. The eligibility for the loan is based on other factors like credit score, income level and repayment history.
For example, in the case of a home loan, you will have to pledge the house that you intend to purchase as collateral to secure the loan. The same goes for vehicle loans. But in the case of an unsecured personal loan, you do not need to pledge any asset to get funds from the lender.
- Loan Amount
The maximum amount of funding you can avail of is also quite different between an unsecured loan and a secured loan. The amount of loan that you can borrow is often much higher with secured loans since they are backed by collateral. That said, the loan amount in the case of secured credit facilities is often limited to around 80% to 90% of the total value of the pledged collateral.
Unsecured loans usually come with much lower borrowing limits, especially if your income or credit score is not high. For example, you can easily get secured personal loans and home loans of ₹25 lakhs and more. Comparatively, unsecured personal loans have a strict cap on the loan amount, with most borrowers offering funding of only up to ₹5 lakhs to ₹10 lakhs.
- Risk for the Borrower
For the borrower, the risk is much higher with secured loans. This is because of the possibility of losing the pledged asset in the case of non-repayment of dues. With unsecured loan options, your risk is much lower since there is no pledged asset to lose.
However, it is important to keep in mind that in the case of non-repayment of both secured and unsecured loans, the damage to your credit score can be quite severe. It can make borrowing in the future a lot more challenging.
- Risk for the Lender
For collateral lenders, the risk is much lower with secured loans since the asset you pledge can be sold to recover any unpaid dues. However, the lending institution’s risk is far higher with unsecured loans with no collateral requirement. That said, lending institutions do have other avenues for recovering their unsecured personal loan dues.
- Interest Rates
Another key difference between secured and unsecured loans is the interest rate. Since the risk for the lending institution is often higher with unsecured loan options, they often charge a higher rate of interest to offset the risk.
Secured loans, meanwhile, usually come with lower interest rates because the lender has the option to sell the pledged asset to recover their dues in the case of non-repayment of dues. Since the risk is lower, the cost of borrowing is also lower.
- Approval Criteria
Usually, the approval or eligibility criteria are often very stringent for unsecured loan options. This is primarily due to the absence of collateral to secure the loan. Unsecured lenders often conduct extensive checks to ensure the creditworthiness and repayment ability of the borrower before granting a loan. Some of the factors that are assessed include the borrower’s income, credit score, liabilities, repayment history and age, among others.
Lenders often have relaxed eligibility criteria for secured loans. Since the presence of collateral acts as a cushion, lending institutions usually do not perform too many checks to determine the worthiness of the borrower. This makes them ideal options for individuals with low credit scores or less-than-ideal repayment histories.
- Loan Tenure
Generally, secured loans offer longer loan tenures of up to 15 or 20 years in some cases. This is often due to the loan amounts being much larger, which require time to be repaid. A classic example of this is a home loan, where most lenders are willing to offer repayment tenures of up to 30 years.
In contrast, unsecured loans offer much shorter tenures, ranging from 12 months to just up to 5 years. While shorter tenures mean quicker repayment, it often leads to higher monthly EMIs, especially if the loan amounts are high. The increased risk associated with unsecured loan options is one of the many reasons for the shorter tenures. By keeping the repayment tenures short, lenders can reduce their exposure to risk significantly.
- Fund Usage
Secured loans often have strict restrictions regarding the usage of funds. For example, a home loan can only be used to purchase a home, and a vehicle loan can only be used to purchase a two-wheeler or a car. The only exception to this is a secured personal loan, which allows you to use the funds as you see fit.
On the other hand, unsecured loan options are far more flexible in terms of fund usage. Lending institutions do not restrict how the funds can be used. For instance, you can use an unsecured personal loan for debt consolidation, home renovations, meeting vacation expenses or paying medical bills.
- Approval Process
Another major difference between secured and unsecured loans is the time taken to approve the credit facilities. Unsecured loans are often approved within a short time frame, ranging from 24 hours to 2 days. Some lenders even offer pre-approved unsecured loans, which are disbursed instantaneously to your bank account.
Meanwhile, secured loans usually have long approval times. The lender needs to physically value and assess the asset you wish to pledge as collateral to secure the loan, which takes time. The loan approval times for secured loans can vary depending on the type of loan and can take anywhere from a few days to a few weeks.
Which Type of Loan Should You Choose?
If you are planning to avail of a loan shortly but are unsure of whether you should go for an unsecured or a secured option, this section can help you make a more informed decision.
You can consider opting for a secured loan if:
- You own a valuable asset that you are comfortable pledging.
- You are looking for a loan that offers lower interest rates and a longer tenure.
- You need a large loan amount and can manage long-term repayment.
- Your credit score is average or low, but your asset value is high.
On the other hand, an unsecured loan might be the more attractive option if:
- You have no collateral to secure the loan or prefer not to risk your assets.
- You need money quickly and for a short duration.
- You’re confident about repaying on time and have a good credit history.
- You want flexibility in how the funds are used.
It is important to remember that understanding your own needs and the terms offered by lenders is crucial to confidently choose between secured and unsecured loans to meet your financial objectives.
Conclusion
With this, you must now be aware of the differences between secured and unsecured loans. Now, both of these options have their own advantages and disadvantages. The choice between the two depends on your individual situation and repayment ability. That said, before you apply for any loan, always remember to compare loan offers from multiple financial institutions. This will help you identify the right lender with the most favourable terms and conditions.
Chuyên mục: Trending gossip