What is the difference between a secured loan and an unsecured loan?

A secured loan is one that is backed by collateral, which is an asset that a borrower offers to a lender to secure the loan. This means that if the borrower defaults on the loan, the lender has the legal right to take possession of the collateral to recoup their losses. Common examples of collateral include real estate, vehicles, or savings accounts.

The presence of collateral not only protects the lender's investment but also typically results in lower interest rates for the borrower compared to unsecured loans, which do not require collateral. Unsecured loans are assessed primarily based on the borrower’s creditworthiness, making them riskier for lenders. Therefore, without the assurance of collateral, the interest rates on unsecured loans are often higher.

Understanding this fundamental aspect of secured loans highlights the key distinction between the two types of loans and shows why borrowers with substantial assets might prefer secured loans for potentially better loan terms.