A personal loan is usually unsecured debt, but secured personal loans do exist, and whether yours is one or the other decides your interest rate, what the lender can do if you stop paying, and how the balance is treated in bankruptcy or on your taxes. Most offers you see advertised are unsecured. Secured versions typically come into play when a borrower’s credit history doesn’t qualify for an unsecured approval, or when the borrower wants a lower rate and has an asset to pledge.
What Makes a Personal Loan Unsecured
An unsecured personal loan rests entirely on your promise to repay. You sign a promissory note spelling out the loan amount, interest rate, payment schedule, and consequences of default. No property is pledged, and no lien is filed anywhere. Under the Uniform Commercial Code, a promissory note qualifies as a negotiable instrument when it contains an unconditional promise to pay a fixed amount on a definite schedule.1Cornell Law School. UCC 3-104 – Negotiable Instrument
Because nothing backs the debt except your word and credit history, the lender can’t take your car or drain your bank account the moment you miss a payment. Collecting on a defaulted unsecured loan requires going to court first. That extra risk to the lender is why unsecured loans charge higher rates and lean toward borrowers with stronger credit.
These loans are sometimes called signature loans because your signature is the only security the lender gets. The contracts tend to be shorter and simpler than secured loan agreements since there’s no collateral to describe, appraise, or register.
What Makes a Personal Loan Secured
A secured personal loan ties a specific asset to the debt. You sign a security agreement that gives the lender a legal claim against that asset until you’ve paid off the balance. Common collateral includes car titles, savings accounts, and certificates of deposit held at the same bank. Some specialty lenders also accept investment portfolios, jewelry, or other high-value items.
To make the claim official, the lender typically files a UCC-1 financing statement with the state. That filing puts other creditors on notice that the asset is already spoken for.2Cornell Law School. UCC-1 Form
The main advantage of securing a loan is the interest rate. With something concrete to fall back on, lenders offer secured personal loans at rates several percentage points below their unsecured products. The average unsecured personal loan rate currently sits above 12%.
How Lenders Decide Which One You Get
Underwriters weigh several factors when deciding whether to offer you an unsecured loan or require collateral.
- Credit score. A FICO score of 670 or above is generally considered “good” credit and opens the door to unsecured offers. The best rates go to borrowers in the 700s. Below 580, most mainstream lenders will decline the application or require collateral.3Experian. What Credit Score Is Needed for a Personal Loan?
- Debt-to-income ratio. Lenders calculate how much of your gross monthly income already goes to debt payments. A DTI below 36% is ideal for unsecured approval, though some lenders will go as high as 50% depending on the rest of your profile.
- Loan amount. Unsecured personal loans range from $1,000 to $100,000 at some lenders, but qualifying at the top of that range requires excellent credit and high income. If you need a large sum and your credit is borderline, pledging collateral can make approval more likely.
- Origination fees. Regardless of loan type, many lenders deduct an origination fee from your disbursement. These fees commonly run from 1% to 8% of the loan amount based on your credit profile.4LendingClub. Personal Loans Rates and Fees
Lenders must use accurate credit data when making these decisions. Under the Fair Credit Reporting Act, furnishers have to maintain reasonable policies for the accuracy of the information they report, and you have the right to dispute inaccurate entries.5eCFR. 12 CFR Part 1022 – Fair Credit Reporting (Regulation V)
What Happens if You Stop Paying
The consequences of default split sharply along the secured-versus-unsecured line, and this is where the distinction has real teeth.
Default on a Secured Personal Loan
When you default on a secured personal loan, the lender can take the collateral without suing you first. Under UCC Article 9, a secured party has the right to take possession of collateral after default as long as it can be done without a breach of the peace.6Legal Information Institute. UCC 9-609 – Secured Party’s Right To Take Possession After Default For a car loan, a recovery agent can show up and tow the vehicle from your driveway. For a savings account or CD pledged as collateral, the bank simply applies your funds to the balance.
After repossessing and selling the collateral, the lender can pursue a deficiency judgment if the sale didn’t cover the full debt. If your car sells at auction for $8,000 but you owed $12,000, the lender can go to court for the remaining $4,000 plus costs. Not every state allows deficiency judgments on every type of secured loan.7Federal Trade Commission. Vehicle Repossession
Default on an Unsecured Personal Loan
Without collateral, the lender’s only path to your money runs through a courtroom. The lender or a collection agency must file a lawsuit, serve you with papers, and win a judgment before touching your wages or bank accounts.8Consumer Financial Protection Bureau. What Should I Do if I’m Sued by a Debt Collector or Creditor?
Once the lender has a judgment, the collection tools get more aggressive. Federal law caps wage garnishment at 25% of your disposable earnings per week, or the amount by which your weekly earnings exceed 30 times the federal minimum wage, whichever produces the smaller garnishment.9Office of the Law Revision Counsel. 15 U.S. Code 1673 – Restriction on Garnishment A judgment can also produce a lien on real estate you own or a freeze on non-exempt bank accounts.
Bank Set-Off Cuts Across Both Types
Here’s something that catches borrowers off guard. If you owe money to the same bank where you keep your checking or savings account, the bank may be able to pull funds from your deposit account to cover a defaulted loan without a court order. This right of set-off is typically buried in the account agreement you signed when you opened the account. It applies to both secured and unsecured loans held at the same institution, though banks generally cannot use set-off for missed credit card payments. Funds that are exempt from garnishment under federal law, like Social Security benefits, are usually protected from set-off as well.
Credit Report Damage
A civil judgment or collection account from a defaulted personal loan can remain on your credit report for up to seven years from the date of entry, or until the statute of limitations expires, whichever is longer.10Office of the Law Revision Counsel. 15 U.S. Code 1681c – Requirements Relating to Information Contained in Consumer Reports
How Bankruptcy Handles Each Type
The secured-versus-unsecured split plays a decisive role in bankruptcy, and understanding it can prevent costly surprises.
Unsecured personal loans are among the most straightforward debts to discharge. In a Chapter 7 case, which typically wraps up in about four months, an unsecured personal loan balance is wiped out entirely along with credit card debt and medical bills. In a Chapter 13 case, the loan is folded into a three-to-five-year repayment plan, and whatever remains at the end of the plan is discharged.
Secured personal loans are more complicated because discharge eliminates your personal liability for the debt but does not remove the lender’s lien on the collateral. If you want to keep the property, you generally have two options. You can reaffirm the debt, signing a new agreement to remain personally liable and continue paying as if the bankruptcy never happened. Or you can redeem the property by making a single lump-sum payment equal to the collateral’s current market value, which may be less than what you owe.11United States Courts. Reaffirmation Documents (B240A)
If you don’t want the property, you can surrender it. Any remaining balance after surrender becomes unsecured and gets discharged with your other qualifying debts. For certain household goods and tools of the trade used as collateral, federal bankruptcy exemptions may allow you to strip the lien entirely if the security interest is a nonpurchase-money, nonpossessory lien. The current federal exemption for a motor vehicle is $5,025, and for household goods it’s $800 per item or $16,850 in total.12Office of the Law Revision Counsel. 11 U.S. Code 522 – Exemptions Many states offer their own exemption schedules that may be more generous.
Tax Treatment for Both Types
Borrowing money through a personal loan doesn’t create taxable income because you have an obligation to pay it back. The tax questions show up in two other places: interest deductibility and debt cancellation.
Interest on a personal loan used for personal expenses is generally not tax-deductible. The IRS classifies it as personal interest, the same category as credit card interest and installment loan interest for consumer purchases. There is a narrow exception for car loans: for tax years 2025 through 2028, you can deduct up to $10,000 per year in interest on a qualified new-vehicle loan if the debt was incurred after December 31, 2024, the vehicle’s first use begins with you, and final assembly occurred in the United States. This deduction is available whether or not you itemize.13Internal Revenue Service. Topic No. 505, Interest Expense If you use personal loan proceeds for business purposes, the interest on the business portion may also be deductible on your business return.
If a lender forgives, settles, or writes off part of your balance, the forgiven amount is generally taxable income. When the cancelled amount reaches $600 or more, the lender must send you a Form 1099-C. Even if the cancelled amount is under $600 and you don’t receive a form, you’re still required to report it as other income.14Internal Revenue Service. Form 1099-C Cancellation of Debt
Two major exceptions apply. If the cancellation occurs during a bankruptcy case, the forgiven debt is excluded from income entirely. If you’re insolvent at the time of cancellation, meaning your total liabilities exceed the fair market value of your total assets, you can exclude the forgiven amount up to the extent of your insolvency.15Office of the Law Revision Counsel. 26 U.S. Code 108 – Income From Discharge of Indebtedness
If you’re not sure which category your loan falls into, look at the paperwork you signed. A security agreement or a UCC-1 filing means secured. A promissory note with no reference to collateral means unsecured. Your loan servicer can confirm it in writing if the documents aren’t clear.