The cost of a secured loan is typically lower than the cost of an unsecured loan because…
Ever wondered why secured loans have lower interest rates than unsecured loans? Because they have collateral, lenders are subject to less risk, so the cost of a secured loan is typically lower than the cost of an unsecured loan. But what does this mean if you’re a borrower? Let’s dive in!
Difference between Secured and Unsecured Loan
Before we dive into how much more (or less) you’ll pay for secured loans versus unsecured loans, we should define what these types of loans are.
What Is a Secured Loan?
A secured loan is backed by collateral — an asset, like a house, car or savings account, that the lender can seize if you don’t pay back the loan. They have something to fall back on, so they offer lower interest rates.
What Is an Unsecured Loan?
An unsecured loan does not require any collateral. This includes credit cards, personal loans and student loans. The lender must charge higher interest rates because they have no asset to recover should you default.
How Collateral Can Help You Save On Loan Costs
Pretend you lent money to a friend. If they use, say, their laptop as collateral, you are more sure they will pay you back, aren’t you? Lenders work the same way. They land on an asset linked to the loan, so they care less about losing money.
Less risk makes for lower interest rates
Lenders charge interest rates based on risk. As a secured loan gives collateral, the risk is less, so:
- Lower interest rates
- Longer repayment terms
- Higher loan amounts
Interest Rates on Secured vs. Unsecured Loans
[[Someone horning in on your act: Here’s a money question you can ask — Are education loans worth the cost?]]The financial effect may be as profound as I just indicated. To appreciate the difference, we can look at average interest rates.
Loan Type
Average Interest Rate (%)
Secured Mortgage
3% – 6%
Secured Auto Loan
4% – 7%
Unsecured Credit Card
16% – 25%
Unsecured Personal Loan
10% – 20%
It is thus apparent that secured loans are considerably cheaper due to the lesser risk involved for the lender.
My Own Experience of Secured Loans and Unsecured Loans
- A couple of years ago, I wanted a loan for a car. The bank gave me two options if it to,
- Auto loan at 5% secured with the car as collateral
- Personal line of credit with interest rate 15% p.a.
I went with the secured loan and saved thousands of dollars throughout the repayment period. The lesson? A secured loan: it can mean a huge amount of money!
The Downside of Secured Loans
Secured loans are cheaper, but carry a risk: If you don’t repay, you lose your collateral. Always borrow responsibly.
Best for: Who Should Get a Secured Loan?
If you have equity for collateral and want lower interest rates, then a secured loan is the smartest choice. Ideal candidates include:
- Homebuyers (mortgages)
- Car buyers (auto loans)
- Owners of businesses (secured business loans)
When to Select an Unsecured Loan?
If you don’t have collateral or require quick cash, an unsecured loan might be more ideal. It’s great for:
- Small emergency expenses
- Debt consolidation
- Building credit
Final Thoughts: Pick Your Domains Wisely!
Secured loans are generally cheaper than unsecured loans for a lender because they would have collateral to secure it. Secured loans are cheaper, but you can use unsecured loans in some cases. So think long and hard, weigh the options, and borrow responsibly!