Loans can be categorized into two different types based on the risk involved. These are secured and unsecured loans.
Difference between a secured and unsecured loan
A secured loan is one in which there is a collateral backing. Let us understand the same with an example. When an individual takes an auto loan, a lien is created on the vehicle and the owner cannot sell the same, unless he pays the bank or the financial institution the loan that is outstanding.
Not only for individuals, but, banks also grant corporates loans. These loans could also be backed by assets like land, building etc.
An unsecured loan on the other hand is one in which there is no backing of an asset. As far as banks and financial institutions are concerned the classic case would be personal loans. These types of loans do not have any kind of asset backing. But, these days banks tend to insure personal loans and the insurance premium amount has to be paid by the individual taking the loan. So, here again banks have learnt to play it safe.
However, one area that is certainly not safe for banks is the credit card business. However, this is not strictly a loan, but, people do tend to withdraw cash from credit cards and then default. An area of risk for banks.
Does the difference between secured and unsecured loan really matter?
The difference between the two set of loans really does not matter as far as individuals are concerned. It is the banker who is taking the risk and hence he would prefer taking an asset backed security, what is called as secured loan.
Individuals on the other hand need to be careful as if they take a secured loan they must pay or else there is a danger that the bank may take possession of the asset and liquidate the same.