Secured or Unsecured loan - which one should you go for?

6 MinsJuly 21, 2021

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If you are looking to borrow money, you would typically consider a personal loan. Usually, the processing is quick and you could get the money in a few days. But what if you could get a loan at a lower rate of interest than a personal loan, by pledging an asset you own? The approval may take a bit longer, than a personal loan and may involve more documentation too. These loans are called Secured Loans while a personal loan is an Unsecured Loan.

Difference between Secured and Unsecured Loan:

Let us see the differences between the two kinds of loans in detail.

What is a secured loan?

A secured loan is a loan where the lender gives you a loan in exchange for collateral or security. It could be a physical asset like gold, a house or vehicle or a financial asset like equity shares, fixed deposits, mutual funds, life insurance policies, etc. The lender keeps the security either physically or in terms of a lien on the title until the loan is repaid. If you cannot repay the loan, the lender might sell your collateral to recover their money.

What is an unsecured loan?

An unsecured loan is a loan without the need for you to pledge any collateral. These loans are given solely on your credit history and credit score. Lenders look at your previous repayment history, a steady source of income, payslips for six months or income tax returns, among other factors while sanctioning the loan. Credit cards, personal loans, education loans below a particular amount fall under this category of loans.

What are the differences between both kinds of loans?

Typically, interest rates on secured loans are lower than those on unsecured loans. Lenders also tend to give higher amounts on secured loans than unsecured loans. In addition, payment tenures tend to be longer for secured loans compared to unsecured loans.

Should you consider an unsecured loan?

Unsecured loans are a good option if you want to borrow smaller amounts or if you need funds in a hurry. They are easier to process and quicker to disburse since the lender does not need to evaluate the collateral. In most cases, the loan is approved based on the borrower’s income statement and credit score. For this reason, documentation is also easier in case of an unsecured personal loan.

[Also Read: What should be my credit score to avail loans?]

When does it make sense to take a secured loan?

If you want a higher loan amount at a lower rate, then a secured loan is the right option for you. Secured loans also make sense when you have no/bad credit history.

What are the various kinds of secured loans? How do they work?

When you take a loan against collateral, you get only a certain percentage of the asset's value as a loan. How much of the asset’s value you can get depends on the kind of collateral.

The various kinds of secured loans are:

Loan against property – Loan against property is a loan extended against your residential or commercial property or for purchase of a commercial property. The amount allowed is usually up to 60-65% of the property value. In addition to scrutinising your documents, such as bank statement or income tax returns, and credit score, the bank will also conduct physical verification of the property before approving the loan.

Loan against securities – Loan against securities includes loans against financial instruments such as equity shares, listed bonds, traditional Life Insurance policy, debt and equity mutual funds. The amount of loan varies based on the instrument.

For instance, in equity mutual funds, you can get up to 60% of the net asset value, while in the case of equity, you can get up to 50% of the market value of the shares.

Similarly, in the case of debt mutual funds, you can get up to 85% of the NAV, while in bonds you can get up to 70% of the market price.

Since the value of these instruments is market-linked, lenders follow a system called Mark-to-Market (MTM). This means if a particular share's price or the Net Asset Value (NAV) of MF units falls below the 50-60% level, you may have to provide additional collateral or repay part of the debt.

In instruments with fixed realisable value, such as Life Insurance Policy, the loan can go up to 75% of the policy’s value. It is usually available only against traditional life insurance plans and not Unit Linked Insurance Plans.

Loan against gold- You can also get a loan against your gold jewellery or gold coins, up to 75% of its value. Again, in the case of gold loans, too, if the price of gold falls, you may have to prepay part of your loan before the tenure.

Loan against fixed deposits- Loan against fixed deposits is one of the easiest and fastest secured loans to avail of. You can get a loan of up to 85% of your FD amount, and the interest rate is charged only on the actual amount of loan utilised. You can continue to earn interest on the FD amount, while the rate for the loan is 2% over the FD interest rate.

Axis Bank offices customers a range of secured and unsecured loans. These are tailored to suit customers' financial needs. Click here to find out more.

Disclaimer: The Source, a content creation and curation firm, has authored this article. Axis Bank does not influence the views of the author in any way. Axis Bank and The Source shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.