Unsecured loans vs secured loans

If you find yourself needing to cover an emergency expense or finance an asset, you might apply for one of these: a loan. When things break and kids get sick, we are often left shaking the last Rand from the piggy bank. And then what? You have to borrow – hopefully from a reputable responsible lender.

Of course, you then have to choose the loan that best suits your needs. While there are a myriad of offerings out there, these can all be divided into two broad categories: secure and unsecured loans. Knowing the pros and cons of each can help you choose the right product, and so here we take a look at how the two types of loan compare.

Secured loans

With a secured loan, your lender accepts an asset (e.g. your car) as security that you will pay back the loan. This makes secure loans both safer for the lender and more affordable for the borrower, as the lower risk allows for lower interest rates. But this type of loan is not without its disadvantages. If you defaulted on a payment, you’d risk having the bank claim the collateral (the asset you offered as security). This could mean the loss of your home or vehicle.

So, why would you take out a secured loan?

• It’s the most accessible type of loan
• Mortgages can be restructured to finance other assets
• Interest rates are lower

Disadvantages of a secured loan:

• You could lose your house or car
• The typically longer repayment periods mean that you incur more interest.

Unsecured loans

An unsecured loan is not tied to any asset, so the risk taken on by the lender is greater than the risk associated with issuing a secured loan. To compensate for the increased risk, lenders charge higher interest on these types of loans, making this a potentially expensive way to finance a large expense like a vehicle. For this reason most unsecured loans are taken out to cover smaller personal expenses (personal loans) and study costs (student loans).

Why you might want to take out an unsecured loan:

• To cover an emergency expense like unexpected medical bills
• To pay for an asset that will pay for itself
• To cover student expenses

Disadvantages of an unsecured loan:

• Interest rates are higher than secured
• Debt-to-income requirements are generally stricter. In other words, you won’t be able to borrow as much, and that amount will be tightly correlated with what you earn

If you realise you need a personal loan, you can learn more about lending in our blogs When to take out a personal loan and How to choose a personal loan.