In an ideal world, you would have money to pay for everything you want, but the most significant life move (e.g., buying a house or higher education) requires a loan. The question is, should you put up collateral with a secured loan or nothing with an unsecured loan? In this post, we’ll explore what you should do.
Secured vs Unsecured Loan: The Quick Answer
A secured loan is backed by collateral, like your home or car. Because the lender has something valuable to seize if you don’t pay, secured loans come with lower interest rates, higher borrowing limits, and longer repayment terms.
An unsecured loan doesn’t require collateral. Approval is based on your credit history, income, and financial standing. Since lenders take on more risk, unsecured loans tend to have higher interest rates, stricter approval requirements, and lower borrowing limits.
So, which one should you choose?
- Go with a secured loan if you have assets to back it up. You’ll get better loan terms and a higher chance of approval. Generally speaking, a secured loan is always the best option with a few small exceptions.
- Choose an unsecured loan if you have no collateral but a strong credit score and stable income. It gives you flexibility without risking your property.
Your decision should depend on your financial situation, risk tolerance, and how much money you need. Now, let’s break down each loan type in more detail.
What is a Secured Loan?
A secured loan requires you to put up collateral, something valuable like a house, car, or savings account, to back the loan. If you fail to make payments, the lender has the legal right to seize the collateral to recover their money.
Because lenders take on less risk with secured loans, they typically offer:
- Lower interest rates compared to unsecured loans
- Higher borrowing limits since the loan is backed by a valuable asset
- Longer repayment terms make monthly payments more manageable
Mortgages and auto loans are the most common secured loans, but you’ll also find secured personal loans, home equity loans, and secured business loans.
Why take out secured loans?
For borrowers with valuable assets, secured loans offer a reliable way to access larger sums of money with better terms. Lenders see these loans as lower risk, allowing them to offer lower interest rates than unsecured loans. Borrowers can qualify for higher loan amounts because the lender has a tangible asset to fall back on if payments are not made. This makes secured loans attractive for major expenses like buying a home or car, funding a business, or consolidating debt.
Another advantage of secured loans is the extended repayment period, which spreads payments over a longer timeline.
This structure helps lower monthly payments, making it easier to manage finances without immediate strain. Since lenders feel more confident lending when collateral is involved, secured loans are more accessible for people with lower credit scores. A borrower with imperfect credit may still get approved for a secured loan, whereas an unsecured loan might be out of reach.
While secured loans come with benefits, they also require careful planning. Borrowing against a valuable asset means that failure to repay can lead to losing something important, like a home or car. This is why secured loans should only be used for stable, well-planned financial needs, not risky ventures or speculative investments.
The risks of secured loans
Taking out a secured loan isn’t without risks. If you’re not careful, you could lose valuable assets.
- Risk of losing your property: If you default on payments, the lender can seize and sell your collateral—whether that’s your house, car, or another asset.
- Borrowing more than you need: Higher borrowing limits can be tempting, but overextending yourself can lead to financial trouble.
- Collateral depreciation: Some assets, like cars, lose value over time. If your car is worth less than the remaining loan balance, selling it won’t fully cover your debt.
A secured loan can be smart when used responsibly but comes with significant risks. To minimize these risks, always borrow smart. Stay within your means and only take a secured loan when it’s for something worth the risk.
What is an Unsecured Loan?
An unsecured loan is a loan that does not require collateral. Instead of backing the loan with an asset like a house or car, borrowers qualify based on their creditworthiness, income, and financial history.
Since lenders take on more risk with unsecured loans, they have stricter approval requirements, higher interest rates, and lower borrowing limits.
Approval is largely determined by your credit score and repayment history. A strong credit profile with a history of on-time payments and steady income increases your chances of getting approved with favorable terms. Borrowers with lower credit scores may still qualify but will likely face higher interest rates and stricter repayment terms.
Why take out unsecured loans?
Unsecured loans provide flexibility, especially for borrowers who do not have valuable assets to use as collateral. They allow you to borrow money without putting personal property at risk. For those with good credit and steady income, unsecured loans can be a convenient way to access funds quickly.
Here’s why unsecured loans may be a good option:
- No collateral required means you don’t risk losing personal property if you can’t repay.
- Faster approval process since lenders don’t need to verify assets.
- Flexibility in how you use the funds for personal expenses, debt consolidation, or unexpected costs.
- Good credit can get you competitive rates, making borrowing more affordable.
While unsecured loans offer convenience, they also require responsible borrowing. Without collateral, lenders rely entirely on your ability to repay, and failure to do so can lead to financial consequences.
The risks of unsecured loans
Unsecured loans may not put your house or car at risk, but they can still lead to serious financial trouble. Since lenders take on more risk, they charge higher interest rates, especially for borrowers with lower credit scores. This makes unsecured loans more expensive over time.
Borrowing limits are often lower, and repayment periods can be shorter, leading to higher monthly payments. If you take on too much debt without a solid repayment plan, it can quickly become overwhelming.
Defaulting on an unsecured loan can severely damage your credit score. Lenders may take legal action, garnish wages, or send unpaid debt to collections.
A real-life example of when loans don’t go as planned
Meet Ashley and Brandon. They’re a couple who’s dealt with a lot of troubles, including the backlash of taking out a large loan for surrogacy that didn’t work out. Their credit wasn’t great, so they had to accept a high interest rate.
They went through the entire process and found a surrogate, but nothing worked out. The money was gone, and they were left paying off a loan with “nothing to show for it.” They also had other debts that they were struggling to catch up with, just adding more to the stress of debt.
[00:35:47] Ashley: We took out another loan to pay for a surrogate. But our credit wasn’t great, so our interest rate is high. And we went through the whole process, and we had a surrogate. We went through everything. She ended up pregnant and we lost it. And we went through IVF with her and the transfer didn’t work. And then the money was gone, and there was no baby. So we’re paying that loan, and we have no baby. I don’t want to say I regret it, but we really were motivated to start a family.
[00:36:23] Ramit: So I understand that you’re thinking about starting a family. What’s the financial considerations there?
[00:36:30] Ashley: It’s expensive. That is a large portion of our debt right now.
[00:36:40] Brandon: Yeah.
[00:36:40] Ashley: We were using a surrogate and we had to take out a loan for it. It didn’t work. So we have a loan that we’re paying and obviously nothing to show for it. So for me, that is a big motivator to get our debt paid off.
It’s possible that if the surrogacy had gone through, they wouldn’t feel as defeated as they do now. Having the family they worked toward might have made the financial strain feel worth it. This is a heartbreaking example of how not everything works out, and when it doesn’t, we’re left to pick up the pieces and find a way to move forward.
Should You Take Out a Loan?
While loans can help fund major purchases, consolidate debt, or cover unexpected expenses, they should never be taken lightly. Here are some questions to ask yourself when deciding if you should take out a loan:
What are you using the loan for?
Not all loans are created equal, and some borrowing decisions are smarter than others. Loans are best used for major purchases that provide long-term value or financial growth.
Common reasons people take out loans include:
- Buying a home when paying in full isn’t realistic.
- Purchasing a car to avoid depleting savings on a large upfront expense.
- Starting a business when initial capital is needed to launch.
- Consolidating debt to simplify high-interest payments into a single, manageable loan.
- Investing in education to boost earning potential over time.
These are all justifiable reasons to borrow money, but not every expense should be financed with a loan. If you’re borrowing for luxury items, vacations, or non-essential spending, reconsider whether taking on debt is worth it.
Do you really need the loan?
Before committing to a loan, take a step back and ask yourself if you truly need it.
Could you delay the expense and save up instead? Is there a more affordable option that wouldn’t require borrowing? If the purchase isn’t urgent or essential, avoiding debt may be the better choice.
If a loan is necessary, be sure you can afford the monthly payments. Consider your current financial situation and any potential changes in income. Borrowing should never put you where a single setback could cause financial distress.
Could you handle the consequences of failing to pay the loan?
Taking out a loan always comes with risk. If you can’t make payments, the consequences can be severe. For secured loans, failing to pay means losing your collateral, whether that’s your home, car, or other valuable assets.
For unsecured loans, the impact may not be as immediate, but your credit score will take a major hit. This can make it difficult to get approved for future loans, rent an apartment, or even qualify for certain jobs.
If you default, here’s what could happen:
- Repossession of your car, home, or any secured asset.
- Damage to your credit score that can last for years.
- Debt collection agencies contacting you aggressively.
- Legal action that could result in wage garnishment or court orders.
Before taking out a loan, think about the worst-case scenario. If losing an asset or facing financial penalties would leave you in a bad place, reconsider whether the loan is the right move.
Do you truly understand the risk?
Loans come with more than just the amount you borrow. Interest rates, fees, and repayment terms can make a loan far more expensive than it seems. Some loans have hidden costs, such as prepayment penalties or variable interest rates that increase over time. Before signing anything, make sure you know exactly how much you’ll be paying each month and how long it will take to repay the full amount.
A loan can either be a financial tool or a long-term burden, depending on how well you understand its terms. If you’re unsure about anything in the agreement, take the time to ask questions or seek professional advice.
Example of when debt spirals with loans and credit cards
Meet Emi and Antonio. They’ve been married for six years, but their struggles with debt go back even further. Credit cards, student loans, personal loans—they’ve tried every option to stay afloat.
At one point, they took out $40,000 in student loans, but only part of it went to school. Some went toward a house down payment, and another $10,000 went straight to paying off credit cards. When that wasn’t enough, they opened a $30,000 personal loan, telling themselves this was their last chance to get things under control. It wasn’t.
[00:06:19] Antonio: So because she was in school, we actually went into student loan debt to pay off a lot of stuff too.
[00:06:28] Ramit: You took student loans, and you paid off credit cards?
[00:06:31] Antonio: Mm-hmm.
[00:06:31] Ramit: Okay, how much?
[00:06:32] Emi: It was almost 40k for student loans for actual school. Then we put some of it toward the down payment of the house, then some was for credit cards. There was maybe 10k of that was for credit cards, maybe.
[00:06:45] Antonio: The last one that I can remember was we opened a personal loan through Best Egg.
[00:06:53] Ramit: Uh-huh. How much?
[00:06:55] Antonio: That was 30k, and that’s the one that we had told ourselves when we hit the submit button on that one, hey, this is it. Last chance we get to fix our problems with money. There’s no more options after this. And then we got ourselves in way more.
This is precisely how people end up drowning in debt without realizing it. It starts with a loan that feels manageable, then another to cover past mistakes, then another. Before they knew it, Emi and Antonio weren’t just dealing with debt—they were stuck in a cycle that controlled their entire financial future. This is why it’s so important to understand the entire risk of taking on debt; once you’re in, it’s not always easy to find your way out.
My advice:
If you have the option, a secured loan is almost always better. Lower interest rates, higher borrowing limits, and longer repayment terms make it a more manageable and cost-effective way to borrow.
The key is to use it responsibly and only for stable, well-planned expenses like buying a home, financing a car or consolidating high-interest debt.
Avoid taking out a loan for something uncertain or high-risk. Borrowing money to fund speculative investments, gambling on a business idea with no clear path to profitability, or covering unnecessary spending can put you in serious financial trouble.
If you take out a secured loan and things go south, you risk losing your home, car, or other valuable assets. No monetary gain is worth that level of risk.
Before applying for any loan, have a clear repayment plan. Understand your monthly payments, the total cost of the loan, and what would happen if your financial situation changed. If you’re already struggling with debt or unsure how to manage loan repayments, check out this How to Get Out of Debt Fast (7 practical steps you can start now) for practical steps to stay in control.
6 Mistakes to Avoid When Taking Out Secured and Unsecured Loans
Taking out a loan can be a smart move, but don’t screw it up by making these common mistakes.
1. Not calculating the true cost
Many people focus on the loan amount without considering the full cost. Interest rates, fees, and repayment terms can significantly impact your pay. A low monthly payment might seem affordable, but you could pay thousands more than expected if it stretches over several years.
Before taking out a loan, calculate the total repayment amount, including interest and any extra fees. Use a loan calculator to compare different repayment scenarios. The goal is to find a loan with the lowest overall cost, not just the lowest monthly payment.
2. Overborrowing
Lenders may offer you more money than you need. While it might be tempting to accept a higher loan amount, borrowing more than necessary increases your debt burden and raises the total interest you’ll pay. It can also lead to lifestyle inflation, where you spend more simply because the money is available.
Take only what you truly need and can comfortably repay. Just because a lender approves you for a large sum doesn’t mean you should take it. Keep your debt manageable by borrowing based on necessity, not availability.
3. Skipping the fine print
Loan agreements are full of important details, yet many borrowers skim through them without fully understanding the terms. Hidden fees, penalties for early repayment, or variable interest rates can turn a seemingly good deal into a costly mistake.
Always read the full loan agreement and clarify anything that isn’t clear. Pay attention to interest rates, late fees, prepayment penalties, and repayment schedules. Ask the lender for clarification or a second opinion if anything seems off. A few minutes of careful review can save you from years of financial headaches.
4. Using loans for high-risk moves
A loan should be used for something stable and well-planned, not a gamble. Borrowing money to fund risky investments, play the stock market, or start a business with no proven demand can lead to financial disaster. If things don’t work out, you’re still on the hook for the loan, and with a secured loan, you could lose your collateral.
If you’re considering a loan for an investment, do a risk assessment. Ask yourself what happens if things don’t go as planned. If you can’t afford to lose the money, it’s not worth the risk.
Loans should be used for things with a clear return or necessary life expenses, not speculation.
5. Only paying the minimum
Making only the minimum payment on your loan keeps you in debt longer and costs you more in interest over time. This is especially true for high-interest unsecured loans, where small monthly payments barely cover the accumulating interest.
Whenever possible, pay more than the minimum to reduce your balance faster. Even small extra payments can cut years off your repayment timeline and save you money. If your budget allows, making biweekly payments instead of monthly ones can help you pay off the loan sooner.
6. Ignoring help when you need it
If you’re struggling with loan payments, ignoring the problem will only make it worse. Many people wait until they’re in financial trouble before seeking help, but taking action early can prevent serious consequences.
If you’re having trouble managing your loan, consider these options:
- Talk to your lender to discuss refinancing, hardship programs, or lower payment options.
- Seek financial counseling for expert advice on budgeting and debt repayment strategies.
- Look into debt consolidation if multiple loans are becoming overwhelming.
- Cut unnecessary expenses to free up money for loan payments and avoid default.
Loans should work for you, not against you. If repayment is becoming a burden, taking proactive steps can help you stay in control and avoid long-term financial damage.
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