The Difference Between Secured and Unsecured Credit
Consumers often utilize either unsecured credit or secured credit to get the money they need to make large purchases or pay off debts. Like jelly and jam, these two credit types sound similar. But their underlying differences could flavor your financial future in ways you hadn't considered. Before applying for either type of credit, it’s important to gain a basic understanding of each one.
What is Secured Credit?
Secured credit is a loan or line of credit a lender approves based on collateral or assets you already own, including property or other items of value. This type of credit typically allows for a higher credit limit and lower interest rate since the lender assumes less risk because they have the right to the collateral if you default on the loan.
Types of Secured Credit
Secured credit is often used for major purchases like auto loans and home mortgages. But, other forms include home equity lines of credit, recreational vehicle loans, and some credit cards.
What is Unsecured Credit?
Unsecured credit is a loan or line of credit a lender provides to a qualified applicant based on their credit history, income stability, and other underwriting requirements. Unlike secured credit, lenders require no collateral or assets as a guarantee for repayment. As a result, unsecured credit typically comes at higher interest rates since the lender has more risk if the borrower fails to repay the money as agreed.
Types of Unsecured Credit
When most people think about credit, they often imagine a form of unsecured credit like major credit cards, student loans, or retail charge cards. Other unsecured credit options include personal loans or lines of credit.
How Unsecured and Secured Credit Differ
The primary distinction between the two types of credit is seen at the time of application. While both require proof of a stable income, unsecured credit approval is mainly based on a good credit history and your ability to repay. Secured credit approval is mainly based on your ability to provide collateral and your ability to repay. Lenders may have additional approval requirements applicable to both types of credit.
Another key difference between these two types of credit is what happens if you default on payments. If you fail to repay a secured loan or line of credit as agreed, the lender can take possession of the collateral and sell it to recoup losses they experience from nonpayment.
If you default on unsecured debt, your possessions and assets are typically safe from seizure. But failing to repay unsecured debt is not without consequences. Late payments, delinquency, and collection activity could cause lasting damage to your credit health. A poor credit rating hampers your ability to obtain future financing.
How Unsecured and Secured Credit Are the Same
Once you receive credit approval, the only remaining differences are those established by the creditor. Regardless of which type of credit is used, repayment activity is reported to the major credit reporting bureaus. One type of credit is not favored over the other when calculating credit scores.
Which Type of Credit is Best?
The best type of credit for your situation is the one that matches your financial goals. If you're just starting out or need to repair a damaged credit rating, secured credit may offer an opportunity to quickly build or rebuild your credit profile. If you already have good credit, you can enjoy the flexibility that comes with using unsecured credit. In either case— jelly or jam—the right choice should leave a good taste in your mouth.