What Is an Unsecured Loan, and Is It Right for You?

At some point in your life, you will likely need to borrow money. Perhaps you plan to take out school loans or apply for a mortgage. Whenever you borrow money, chances are good that it will be in one of two forms: secured debt or unsecured debt.

Unsecured debt is a common form of borrowing that includes traditional credit card cards, student loans and medical bills. This type of borrowing is often quicker and easier than applying for secured debt.

“Unsecured debt can be great in a pinch, especially when not using it will result in financial harm,” says Karen Carlson, vice president of education and digital marketing at InCharge Debt Solutions, a nonprofit credit counseling organization.

But if you are not careful, unsecured debt can come with significant drawbacks. “If you are struggling to pay your bills and have a high debt-to-income ratio, you should consider other options,” Carlson says.

Here is more about unsecured debt and when it might be the right choice for you.

The main difference between unsecured and secured debt is that secured debt requires collateral: a valuable asset such as a car, home or savings account the lender can seize if the borrower defaults.

Unsecured debt is issued based on credit and not backed by assets of any kind, which places the lender at greater risk of not being repaid. Lenders typically offset this risk by charging higher interest rates on unsecured debt.

Examples of unsecured debt: 

Examples of secured debt:

Your credit score is a top factor that lenders use to determine your eligibility for an unsecured loan and your interest rate. Because unsecured debt poses bigger risks to lenders, borrowers usually need higher credit scores to qualify compared with secured loans. Strong credit suggests that the borrower has a history of paying back loans.

“The higher the credit score, the better the terms and the lower the interest rates will be,” says Amy Maliga, financial educator at Take Charge America, a nonprofit credit counseling agency.

By contrast, people who do not have an extensive borrowing history or who have poor or no credit scores are less likely to qualify for unsecured debt. If a lender offers an unsecured loan to a borrower with a limited or troubled credit history, the loan will typically come with a low credit limit and high interest rate, Maliga says.

A history of responsible financial behavior is the best way to improve your odds of approval, Carlson says.

“Pay your bills on time, don’t carry balances on your credit cards, and pay down credit card balances you currently carry,” she says.

Which loan type is better can depend on your credit, your financial need and your willingness to put assets at risk.

If you don’t have assets to provide as collateral, an unsecured loan may be your only option. But if you don’t have good credit, a secured loan could offer easier approval. Consider the distinct advantages and disadvantages of unsecured and secured debt to choose the right loan.

An unsecured loan may be best when:

A secured loan may be best when:

Whether you stop paying an unsecured or secured debt, you will wreck your credit. But the consequences of defaulting on an unsecured loan are a bit different from a secured loan.

For both types of loans, most lenders provide a grace period before reporting late payments to the credit bureaus. You can expect late fees and a drop in your credit score.

If you have an unsecured loan, your account likely will be sent to collections after a period of time. In a worst-case scenario, the lender might even sue you to try to collect the debt.

If you fail to pay a secured debt, the lender may take steps to repossess the property you pledged as collateral. The result of defaulting on a mortgage is foreclosure, which can mean losing your home.

Defaulting on a debt, regardless of type, remains on your credit report for up to seven years and hurts your ability to borrow in the future.

Plan to make at least the minimum payment, regardless of whether a debt is secured or unsecured.

You might struggle to pay both secured and unsecured debts and wonder how to prioritize paying them off. If you find yourself in this position, pay off unsecured debts first, Carlson says.

“Unsecured debt is often the highest-interest debt a person faces and should be prioritized to pay off first and fast,” she says.

Secured debts, such as a mortgage, typically have lower interest rates, “and you can make payments over a longer time horizon,” Carlson adds.

Also, unsecured debts can be easier to pay off, Maliga says, because the balances are often relatively low. “Once the unsecured debt is paid off, they can make extra payments on their secured debt to whittle down the principal balance more quickly,” she says.

But if you truly cannot pay both forms of debt, you may be better off covering your secured debt first because you have more at stake if you don’t.

“If consumers are struggling with which debts to pay, they should always pay these loans first since the collateral could be seized for nonpayment of the loan,” Maliga says.