Difference Between Secured & Unsecured Loans?

Business | Know More 24 November 2021

The two most common types of loans availed by people are personal loans and business loans. They are both intended for different purposes, have different borrowing limits and have different terms and conditions associated with them. One of the chief ones being secured or unsecured. Let us examine their definitions and key differences between secured and unsecured loans.

Difference Between Secured & Unsecured Loans?

What is a Secured Loan?

As the name suggests, secured loans are provided by banks and non-banking financial companies (NBFC) in lieu of some collateral that needs to be put up as security by the borrower. This collateral can be in the form of the new item being purchased and the ownership rights being in the name of the lender till the amount is repaid, for example, car, house, shop. In other cases, it could be an existing security owned by the lender. These securities can be shares, stocks, gold, property et al.
Several financial institutions have many such secured business loan products available in their portfolio like home equity line of credit, loan against property, loan against securities, gold loan etc.

Secured business loans are the most common method of availing business loans. This is because typically larger sums need to be borrowed, which requires the lending institution to safeguard their interests by making the borrower put up a collateral. These also involved longer repayment terms and competitive interest rates. Be cautious, a secured loan entails that in case of defaulting in payment or reneging from the repayment contract, the lender will have the right to sell off the collateral to make up for their losses.

What is an Unsecured Loan?

Contrary to secured loans, unsecured loans do not require any collateral or security on the borrower’s part. From a lender’s perspective, this makes these loans riskier with respect to repayment and the credit risk of defaulting. To offset this risk, unsecured business loans and other types of unsecured loans come with higher interest rates and shorter repayment tenure. The borrowing limits are also lower, as the lenders do not wish to pump large amounts without receiving any security in return as assurance. However, it is not as if the lenders blindly provide unsecured loans. There are certain factors that come into play during the financial assessment of the borrowers; such as the credit score, risk profile, past track record, payment history, current income, existing debts, etc. Based on a combination of these factors, the borrowing limit, interest rate and repayment tenure are locked. Some typical examples of commonly occurring unsecured loans are; credit cards, personal loans and student loans.

In Summation

To summarize what we have discussed above, the critical difference between an unsecured and secured loan is the requirement of a collateral for securing the loan. In the case of the secured loans, some sort of tangible collateral needs to be placed under the temporary ownership of the lender. This is why most business loans are in the form of secured loans.

The collateral allows for higher borrowing limits, better rates and longer repayment terms due to the assurance which is with the lender. In case of non-repayment, the lender has the right to liquidate the security or collateral and balance their originally lent amount.

Business loans may be taken as secured loans as well, but the amount might be low and the interest rate high. Overall, not the most ideal option. On the other hand, personal loans are frequently unsecured and offered on the basis of the borrower's credit rating and financial history.

Due to the aforementioned reasons, one may conclude that secured loans are easier to obtain and offer more benefits to the borrower; however, this largely depends on your individual needs and requirements. It also depends on your ability and willingness to put up a collateral in return for the loan. In the case of smaller amounts intended for personal use, unsecured loans might be more apt.

Visit your preferred lender’s website to compare the terms and rates before making your decision.

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