Unsecured loans do not require collateral and rely on the borrower's creditworthiness, while secured loans require collateral such as property or vehicles. Unsecured loans typically have higher interest rates due to increased lender risk, whereas secured loans offer lower rates because the collateral mitigates default risk. Both loan types can impact credit scores, but defaults on secured loans may result in asset seizure.

The distinction between unsecured and secured loans hinges on risk management and lender requirements. Unsecured loans, like personal loans or credit cards, accounted for approximately $1.2 trillion in consumer debt as of Q2 2023, per the Federal Reserve, with average interest rates exceeding 20% for credit cards. Secured loans, such as mortgages and auto loans, represented $11.5 trillion in household debt in the same period, benefiting from lower rates—around 4-6% for fixed-rate mortgages—due to collateral-backed repayment guarantees. Data from the New York Fed shows that unsecured loan defaults rose by 15% year-over-year in 2023, compared to a 5% increase in secured loan defaults, underscoring the higher risk associated with unsecured debt. Lenders also use collateral as a risk offset; for example, auto loan defaults fell 8% in 2022 despite economic volatility, as repossessions offset losses. This risk mitigation strategy reinforces why secured loans are generally cheaper and more stable for lenders, translating to better terms for borrowers with collateral. Ultimately, the choice between loan types depends on the borrower’s assets, credit profile, and repayment capacity.