Sivaram and his family have been working from home for the past 15 months. Luckily, 2021 has been financially rewarding as Sivaram’s e-commerce business started flourishing. He is now planning to renovate his house to make space for all family members working online. Since his funds are blocked in his business, he wishes to take a personal loan for renovating his home.

Sivaram approached different lenders for a personal loan at the best terms. However, he is confused by the various loan products in the market. The interest rate varies depending on whether the loan is secured or unsecured, i.e., whether collateral is provided.

Let’s help Sivaram make a sound decision.

Secured loan

A secured loan is a loan that provides some tangible security to the lender in case the borrower defaults in the repayment of the loan. For example, a home loan is secured by the home’s mortgage, and a vehicle loan is secured by the vehicle or any other security. Likewise, a personal loan may be blocked by offering shares, gold, or other savings instruments such as NSC certificates or fixed deposits. In Sivaram’s case, he can procure a personal loan for home refurbishing by offering security in the form of a vehicle, shares, gold, or other savings instruments.

In secured loans, the lender is protected by the collateral or asset provided to him as a security. In other words, if the borrower consistently defaults in the payment of EMIs, the lender can dispose of the mortgaged home, vehicle, or gold to recover the funds lent to the borrower. Hence, considering that the collateral protects the lender, the interest rates are low for secured loans.

Normally, interest on secured loans ranges from 6.5% to 15% depending on the lender’s policies, collateral offered, tenure of the loan, credit score of the borrower, and other factors.

Unsecured loan

In stark contrast to secured loans, unsecured loans are not backed by any security or collateral from the borrower. They are generally granted depending on the credit score and financial standing of the individual. In some cases, personal loans may be guaranteed by the individual or any third party; for instance, student loans are usually certified by the student’s parents. Personal loans like credit card loans, current account overdraft balances, student loans, personal loans for travel, shopping, or home renovation are examples of unsecured loans.

Based on the borrower’s financial standing, income statements, and credit score, lenders are willing to lend to creditworthy borrowers without any collateral. The lender assumes a slightly higher risk in unsecured loans and agrees to lend based on the business acumen and algorithmic analysis that not all unsecured loan borrowers would default. Hence, a higher interest rate on unsecured loans is justified. Typically, interest on secured loans ranges from 8.5% to 33%.

The choice

Sivaram can choose to borrow a personal loan for renovation as a secured or an unsecured loan. If Sivaram provides security in shares, fixed deposits, vehicles, or gold, the loan can attract lower personal loan interest rates. However, if he chooses not to provide any security, the lenders may still be willing to lend him, depending on his financial standing. However, they may charge a slightly higher interest rate.

It would now be clear that secured loans carry a lower interest rate as compared to unsecured loans. Consider using a personal loan EMI calculator to determine your loan eligibility based on variables like your financial standing, the loan amount, interest rate, and tenure.