Chances are at some point you’ll take out a loan of some kind. After all, the average debt per American is $90,460 according to a 2021 CNBC report. If you’re considering taking out a loan, it will help you to be as educated about loans as possible. There are a number of things to know. For instance: What is meant by a secured loan? How is it different from an unsecured loan? Is one better than the other? To help answer these questions, let’s talk about collateral first.
What is collateral?
Collateral is a piece of property that a borrower must hand over to their lender if they cannot or do not make payments on a loan. This ensures that the lender does not take a complete financial loss if the borrower is no longer making payments. With car loans, the vehicle itself functions as the collateral. So, if payments aren't made on a car loan, the borrower may be required to surrender the vehicle to the lender. With mortgages, the house acts as the collateral.
Although vehicles and houses are some of the most common kinds of collateral, lots of things can act as collateral as well. Some examples are stocks, jewelry, fine art, precious metals, collectibles, and recreational vehicles.
Secured vs. Unsecured Loans
Once you understand what collateral is and how it works, the difference between secured and unsecured loans is simple to understand. Secured loans are backed by collateral while unsecured loans are not. There are some pros and cons to both types of loans. You may also hear these two terms referred to as "secured" or "unsecured debt."
An unsecured loan might spare you the pain of surrendering any collateral if payments aren't made. However, defaulting on an unsecured loan can still affect your credit history/score and subject you to collection attempts.
Since secured loans are backed by collateral, you may be able to get a lower interest rate and/or a larger loan. If you don’t have the best credit, you might be able to get a loan easier if it is secured.