What is the difference between a secured and unsecured loan?

A secured loan requires collateral, which is an asset that the borrower pledges to the lender as a guarantee against default. If the borrower fails to repay the loan, the lender has the right to seize the collateral to recover their losses. Common examples of secured loans include mortgages and auto loans, where the property or vehicle serves as the collateral.

In contrast, an unsecured loan does not involve any collateral; instead, it is based on the borrower's creditworthiness and ability to repay. Because there is no collateral to back the loan, lenders often assess the borrower’s credit history and income level more thoroughly. Unsecured loans typically include personal loans and credit cards.

While interest rates can vary based on several factors, secured loans generally come with lower interest rates due to the reduced risk for lenders, as they have collateral to claim. Unsecured loans tend to have higher rates of interest because they represent a higher risk for lenders.

Options that suggest the specific use of loans or governmental guarantees do not accurately define the fundamental distinction between secured and unsecured loans, as the classification is primarily about the presence or absence of collateral.