Most personal loans are unsecured, meaning you don't pledge collateral
An unsecured personal loan is a loan the bank gives you based on your credit score and income, not on something you own. You don't put up your car, house, or savings as collateral. If you don't pay it back, the lender can't seize an asset — they can only sue you, report the debt to credit bureaus, or send it to a collection agency.
A secured personal loan works differently. You pledge something you own — usually a savings account, certificate of deposit (CD), or sometimes a vehicle — as collateral. If you stop paying, the lender can take that asset to recover their money. Secured personal loans are less common than unsecured ones, but they exist, and they carry different trade-offs.
Most people who take out a personal loan get an unsecured one. That's what banks advertise, and that's what most online lenders offer. But knowing the difference matters because it changes what happens if you can't pay, and it changes the interest rate you'll see.
Key Takeaways
- Unsecured personal loans don't require collateral, so the lender takes on more risk and charges higher interest rates to offset that risk.
- Secured personal loans require you to pledge an asset like a savings account or CD, which lowers the lender's risk and usually results in a lower interest rate for you.
- If you default on an unsecured loan, the lender can sue and report to credit bureaus but cannot seize your assets; if you default on a secured loan, they can take the collateral.
- Unsecured loans are easier to get if you have decent credit, while secured loans may be an option even with lower credit scores because the collateral reduces the lender's risk.
Why unsecured loans charge higher interest rates
When a lender gives you money with no collateral, they're betting entirely on your promise to repay. If you disappear or declare bankruptcy, they have no asset to recover. That risk is real, and lenders price it in. An unsecured personal loan typically carries an interest rate between 6% and 36%, depending on your credit score, income, and the lender.
The better your credit score, the lower your rate will be on an unsecured loan. Someone with a 750+ credit score might get 6% to 10%, while someone with a 600 credit score might see 25% to 36%. The lender is adjusting the rate to match the risk they perceive.
This is why unsecured loans are sometimes called "signature loans" — your signature and your creditworthiness are all the security the lender has. They're betting on you, not on an asset they can sell.
How secured loans work and when they make sense
With a secured personal loan, you put money or an asset into the lender's control as collateral. The most common type uses a savings account or CD. You deposit $5,000, the lender holds it, and they lend you $5,000 (or sometimes a bit more). You make monthly payments on the loan, and if you pay it off, you get your collateral back.
Interest rates on secured personal loans are typically lower — often 2% to 10% — because the lender's risk is much lower. They already have your money sitting in an account. If you stop paying, they straightforward keep it.
Secured loans make sense in a few situations: if your credit score is very low and you can't get approved for an unsecured loan, if you want to build credit history and need a lower rate to make the payments manageable, or if you're trying to rebuild credit after a past problem. Some people also use them as a disciplined way to borrow against their own savings.
What happens if you can't pay back an unsecured loan
If you miss payments on an unsecured personal loan, the lender will contact you to collect. They'll report the missed payments to the three credit bureaus — Equifax, Experian, and TransUnion — which will damage your credit score. After several months of non-payment, they may sell the debt to a collection agency or file a lawsuit against you.
If they win a lawsuit, they can get a judgment against you. Depending on your state, that judgment may allow them to garnish your wages, place a lien on your house, or freeze your bank account. But they cannot straightforward take your car or your home without going through the court system first.
The key point: with an unsecured loan, the consequences are legal and financial (damaged credit, potential wage garnishment), not when ready asset seizure.
What happens if you can't pay back a secured loan
If you default on a secured personal loan, the lender can take the collateral without a court order. If you pledged a savings account, they straightforward keep the money. If you pledged a CD, they cash it out. The process is faster and simpler than with an unsecured loan because the collateral is already in their possession or easily accessible.
You'll still face credit damage and collection efforts for any remaining balance if the collateral doesn't cover the full loan amount. But the when ready consequence is loss of the asset you put up.
This is why secured loans are lower risk for the lender — they have a direct, fast way to recover their money if you don't pay.
Secured loans and credit building
Many people use secured personal loans specifically to build or rebuild credit. Here's how it works: you deposit $1,000 into a savings account, the lender holds it as collateral, and they lend you $1,000. You make monthly payments over 12 to 24 months, and the lender reports your on-time payments to the credit bureaus.
Because you're paying on time and the lender is reporting it, your credit score gradually improves. Once you've paid off the loan and your score has risen, you'll be able to get an unsecured loan at a better rate. The secured loan was a stepping stone.
This strategy works because the lender has no real risk — they're holding your money — so they're willing to lend to someone with poor credit. And because you're making payments on a loan (not just paying down a credit card), it shows lenders that you can handle installment debt, which is valuable for your credit profile.
How to know which type you're getting
When you explore for a personal loan, the lender will tell you upfront whether it's secured or unsecured. If they ask you to pledge collateral, it's secured. If they don't, it's unsecured. The loan documents will spell this out clearly.
If you're shopping around, compare both the interest rate and the type. A secured loan at 5% might look better than an unsecured loan at 12%, but remember that with the secured loan, you're risking an asset. With the unsecured loan, you're only risking your credit and the possibility of wage garnishment.
Most online lenders and banks offer unsecured personal loans as their main product. Secured personal loans are more common at credit unions and smaller banks, though some online lenders offer them too. If you're interested in a secured loan, ask your bank or credit union whether they have one available.
Frequently Asked Questions
Can I get an unsecured personal loan with bad credit?
It depends on how bad your credit is and which lender you approach. Traditional banks usually require a credit score of at least 620 to 640. Online lenders and credit unions sometimes work with lower scores, but the interest rate will be higher. If you can't get approved for an unsecured loan, a secured loan may be your option.
What if I pay off a secured loan early?
You can usually pay off a secured personal loan early without penalty, though some lenders charge a small prepayment fee — check your loan agreement. Once you've paid it off, the lender releases your collateral back to you. Your on-time payment history stays on your credit report and continues to help your credit score.
Is a secured personal loan the same as a credit-builder loan?
They're similar but not identical. A credit-builder loan is a specific type of secured loan designed to help you build credit. With a credit-builder loan, the lender holds your deposit in a savings account and you make payments to build credit history. A secured personal loan can serve the same purpose, but it's a broader category that includes any loan backed by collateral.
Can I use my car as collateral for a personal loan?
Some lenders will accept a vehicle as collateral for a secured personal loan, but it's less common than using a savings account or CD. If you do pledge your car and default, the lender can repossess it. This is riskier than pledging money in a savings account, so ask the lender about their specific policies before you agree.
Will a secured personal loan help my credit score more than an unsecured one?
Both types help your credit score if you make on-time payments, because both are reported to the credit bureaus. The difference is that a secured loan may be easier to get approved for if your credit is poor, so it gives you the opportunity to build history. The credit-building benefit comes from making payments on time, not from whether the loan is secured or unsecured.