Secured or Unsecured: What You Put on the Line

The difference comes down to what the lender can take

Every loan gives the lender ways to collect if you stop paying: collection calls, negative marks on your credit reports and, eventually, a lawsuit. A secured loan adds one more. The lender holds a claim, called a lien or security interest, on specific property, and it can take that property to recover what you owe.

The CFPB also notes that secured loans can be easier to get with no credit history or a lower score, because the collateral reduces the lender's risk. Some require a down payment.

What the lower rate is worth in dollars

Survey averages hint at the gap, though they mix different loans and terms: the Federal Reserve's 7.17% is for 72-month new car loans, the 11.90% for 24-month personal loans. The clearer test is your own quotes. Say you need $15,000 over 60 months and two lenders quote you 8% secured and 14% unsecured:

The secured loan saves $44.87 a month and $2,692.20 over five years. That saving is real. So is the risk: if a job loss means you can't pay, the unsecured lender can damage your credit and sue, but the secured lender can also take the car you need to get to the next job. Before you pledge anything, ask yourself what your plan would be if you had to go three months without a paycheck, and whether that plan still works without the collateral.

Common secured loans and what's at stake

What happens to the collateral if you can't pay

Using a repossessed car as the example, the CFPB describes the process this way. State laws differ, so check your contract and your state's rules.

1. 1 The lender takes the car and can charge a repossession fee, which must be reasonable. Some states let you reinstate the loan by paying the overdue amount plus repossession costs.
2. 2 You get notice before the sale. For a public auction the lender must give the date, time and place; for a private sale, the date after which the car may be sold.
3. 3 You may redeem the car before it's sold by paying the full loan balance plus repossession costs.
4. 4 The car is sold, and the sale must be commercially reasonable. If it sells for more than you owe plus fees, the surplus is yours.
5. 5 Any shortfall is still your debt. Owe $10,000, and a $7,500 sale leaves a $2,500 deficiency balance plus fees, which can go to a debt collector. The repossession can stay on your credit reports for up to seven years.

The lesson: losing the collateral doesn't always end the debt. If you see trouble coming, call the lender before you miss a payment; our guide to a missed loan payment covers what to ask for.

Legal limits on what a lender can take as security

• Household goods: under the FTC's Credit Practices Rule, a lender can't take a security interest in household goods you already own, such as furniture, appliances, clothing or kitchenware, unless the loan is buying them.
• Servicemembers: the Military Lending Act caps most consumer loans at a 36% MAPR and bars lenders other than banks, savings associations and credit unions from taking a vehicle title as security. Loans secured by the car or home being bought are outside the act.
• Spouses: under Regulation B, a lender generally can't require your spouse to sign if you qualify on your own. On a secured loan, it may ask your spouse to sign the papers needed to make jointly owned collateral available, such as the lien.

How to choose between them

• Choose secured if the rate gap is wide, your income is stable and losing the collateral wouldn't wreck your ability to work or stay housed.
• Choose unsecured if the property is essential, your income is uncertain, or the quotes are close enough that the risk isn't worth the saving.
• With no credit history, a savings-secured loan or a cosigner can be the way in; see borrowing with no credit history.
• Whatever you pick, compare APRs for the same amount and term, and ask the lender to put the collateral terms in writing.

Common questions