Your transmission died and you need a new car. Your water heater broke and you received a large medical bill. And all of this happened while you’re in between jobs.
Life happens, and now, despite your best efforts to live from an emergency savings account, you need a personal loan to pay for the damages.
By “personal loan,” I’m not referring to a loan from a friend or family member. Instead, I’m referring to a loan from a company like SoFi, Avant, Prosper, or Lending Club, which gives loans to individuals.
You need to decide whether to apply for a secured loan or an unsecured loan. Which is better? To answer that question, you need to know the basic differences of the loans before deciding which is right for you.
Secured personal loans
Secured loans offer the least risk to lenders. If you get approved for a secured loan, you’ll have to offer up something of value as collateral.
Examples of secured loans:
- (Some) personal loans
- Mortgages
- Home equity loans
- Home equity lines of credit
- Car or vehicle loans (including RVs, boats, etc.)
The lender will hold the title or deed of your collateral until you repay your loan in full. If you don’t make your payments, the lender will be able to recoup their losses by going after the item of value you put on the line to get the loan. Your car, your house, or extra vehicles like motorcycles or RVs are typical examples of collateral.
Secured loans typically have lower interest rates. However, since secured loans are usually for larger amounts, the payback period can be up to 30 years in some cases, meaning you could end up paying more in interest in the long run.
Unsecured personal loans
Unsecured loans don’t require collateral. However, because they mean more risk for the lender, the interest rates on unsecured personal loans will be much higher than secured personal loans.
Examples of unsecured loans:
- (Some) personal loans
- Student loans
- Small home improvement or repair loans (usually less than $5000)
- Personal lines of credit
Unsecured loans can be difficult to get, especially if you have a low credit score. The higher your credit score, and the better your credit repayment history, the more likely you are to be able to get an unsecured personal loan with a good interest rate. Also, because of the risk to the lender, companies typically don’t offer unsecured loans without a cosigner for more than $5,000.
If you need a loan but don’t have anything of value to offer as collateral, an unsecured loan cosigned by someone with a better credit score may be your only option.
If you aren’t able to make your payments, the cosigner would be responsible for paying back your loan. (Read: don’t ever put a friend or family member in this position unless you have no other choices. Friends don’t let friends cosign on loans).
Which is best: secured vs. unsecured loan?
Secured and unsecured loans affect your credit score similarly. Borrowed money is debt, secured or not.
Despite their basic differences, secured and unsecured loans have similarities. Late payments affect your credit score and repayment history the same way, for example. A single 30-day late payment can drop your credit score by 60 points or more.
The default process on both loans work the same way as well. If your account is 150 days overdue or more, the lender will report your default to the credit bureau.
Lenders can either repossess your collateral items for secured loans or pass your debt to collection companies. They can even elect to take you to court to recoup their losses. If you lose in court, you could end up facing wage garnishment and tax refund withholding.
Defaulting on a personal loan for a home (i.e. foreclosure) can affect your credit score for seven years. If you decide to get a secured loan, make sure you have the income security to make payments on time.
The bottom line
Secured and unsecured loans aren’t better or worse. They’re just different. Debt is serious business, and both types of loans can carry dire consequences.
If you get a secured loan, will you be willing to lose your house or car if you’re not able to make payments? If you get an unsecured loan, are you willing to deal with the threat of collections or wage garnishment?
If you need a loan, think carefully about whether you’re able to make the payments – and also, whether you’re willing to deal with the consequences if you can’t.
Avoid taking on new debt, if possible, by using your savings or finding another way to deal with your problem without taking out a loan. Trim your spending in other areas of your life. Find ways to earn extra money on the side.
If you do need to take out a personal loan, understand the distinctions between the various loan products offered by banks and financial institutions. Take out the smallest loan amount that you need, and repay it as quickly as you can.
Interested in a personal loan?
Here are the top personal loan lenders of 2017!| Lender | Rates (APR) | Loan Amount | |
|---|---|---|---|
| 1 Includes AutoPay discount. Important Disclosures for SoFi. 2 Important Disclosures for Citizens Bank. SoFi Disclosures1Terms and Conditions Apply: SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. To qualify, a borrower must be a U.S. citizen or permanent resident in an eligible state and meet SoFi's underwriting requirements. Not all borrowers receive the lowest rate. To qualify for the lowest rate, you must have a responsible financial history and meet other conditions. If approved, your actual rate will be within the range of rates listed above and will depend on a variety of factors, including term of loan, a responsible financial history, years of experience, income and other factors. Rates and Terms are subject to change at anytime without notice and are subject to state restrictions. SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income Based Repayment or Income Contingent Repayment or PAYE. Licensed by the Department of Business Oversight under the California Finance Lender Law License No. 6054612. SoFi loans are originated by SoFi Lending Corp., NMLS # 1121636. (www.nmlsconsumeraccess.org) Citizens Bank Disclosures1Personal Loan Rate Disclosure: Variable rate, based on the one-month London Interbank Offered Rate (“LIBOR”) published in The Wall Street Journal on the twenty-fifth day, or the next business day, of the preceding calendar month. As of July 1, 2017, the one-month LIBOR rate is 1.22%. Variable interest rates range from 6.01% - 15.96% (6.01% - 15.96% APR) and will fluctuate over the term of your loan with changes in the LIBOR rate, and will vary based on applicable terms and presence of a co-applicant. Fixed interest rates range from 5.99% - 16.24% (5.99% - 16.24% APR) based on applicable terms and presence of a co-applicant. Lowest rates shown are for eligible applicants, require a 3-year repayment term, and include our Loyalty and Automatic Payment discounts of 0.25 percentage points each, as outlined in the Loyalty Discount and Automatic Payment Discount disclosures. Subject to additional terms and conditions, and rates are subject to change at any time without notice. Such changes will only apply to applications taken after the effective date of change. |
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 | 5.67% - 29.99% | $1,000 - $50,000 | Visit Upstart |
 | 5.17% - 14.24%1 | $5,000 - $100,000 | Visit SoFi |
 | 8.00% - 25.00% | $5,000 - $35,000 | Visit Payoff |
 | 5.99% - 16.24%2 | $5,000 - $50,000 | Visit Citizens |
 | 5.99% - 35.89% | $5,000 - $50,000 | Visit LendingClub |
 | 5.25% - 12.00% | $2,000 - $50,000 | Visit Earnest |
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