How do secured loans differ from unsecured loans?

Secured loans are distinct from unsecured loans primarily based on the requirement for collateral. When an individual takes out a secured loan, they must provide an asset, such as a house or a car, as collateral. This means that if the borrower fails to repay the loan, the lender has the right to take possession of the collateral to recover the owed amount. The presence of collateral reduces the risk for the lender, often resulting in more favorable loan terms and lower interest rates.

In contrast, unsecured loans do not require collateral. This means lenders rely more on the borrower's creditworthiness and income when approving an unsecured loan. Because there’s no collateral involved, the risk for lenders is higher, which typically results in higher interest rates for unsecured loans. Understanding this fundamental difference between secured and unsecured loans is crucial for anyone managing personal finance, as it can significantly impact borrowing costs and financial risk.