A secured loan involves borrowing an amount of money and ‘securing’ it against a valuable asset such your home or your car.
An unsecured loan is not secured against anything, but interest rates are often a bit higher because of the lack of security and you are usually not able to borrow as much as you could with a secured loan.
There is a risk of your asset being repossessed if the loan is not repaid on time. With large amounts typically borrowed, the lender has some security that they will be able to recover the amount they lend out. You will only be able to borrow an amount that is in keeping with the amount of equity you have in that asset.
If you have paid-off 40% of your mortgage, for instance, the equity in your home is that 40% of its worth. This deciphers the upper limit of how sizeable your secured loan could be.
If you default on an unsecured loan, your credit rating will be negatively affected and you will face legal issues.
Examples of secured loans include:
- homeowner loans
- car loans
- logbook loans
- development loans
- bridging loans
- debt consolidation loans
- first charge loans/first charge mortgages
- second charge loans/ second charge mortgages
Examples of unsecured loans include:
- personal loans
- flexible loans
- emergency loans
- quick cash loans
- short-term loans
- credit card loans
- payday loans
- peer to peer loans
- wedding loans
- funeral loans
Guarantor loans do not fall strictly under either category; they are unsecured in that there is no need for collateral to be put down and, as such, there is no risk of repossession. However, they must involve a second person (a ‘guarantor’) who acts as your form of security. This person is responsible for repaying your loan if you default on it: their finances are the collateral.
How Does The Criteria Differ?
A secured loan requires you to have a valuable asset that you can put towards your loan such as a car, property or valuable item like jewellery or art. There are some secured products where you require a good credit score such as borrowing for a mortgage. However, unsecured and even the likes of payday loans are generally good for people who have bad credit ratings who, for that reason, do not have easy access to a secured loan.
If you wish to get an unsecured loan, you should ideally have a good credit score or a regular income so that the lender can trust that you will be able to make your repayments.
If you have a poor credit rating, but do not have the assets for a traditional secured loan, then you might consider getting a guarantor loan instead. You may still be granted an unsecured loan if your credit score is not great, it is just likely that you will be charged a higher interest rate to account for the risk that the lender is taking in allowing you to borrow from them.
Repaying your loan
Secured loans tend to have longer loan terms, partly because when you take out a secured loan, it is usually of a larger sum than when you take out an unsecured loan. The size of the loan, then, reflects how long it will take you to repay it.
The term of any payday or unsecured loan will depend on the lender itself and each customer’s individual circumstances.
Types of unsecured loans such as flexible loans may allow you to repay your loan early without any early repayment fees, as well as decide to weight your monthly repayments as you should wish. Therefore, instead of paying an equal percentage of your debt back each month, you may decide to pay back a higher percentage one month, and a smaller one the next.
Secured loan terms do not usually allow for this sort of flexibility when it comes to repayments.
The cost of secured and unsecured loans
Expressed as an annual percentage rate (APR), the rates for secured loans are usually a lot less than unsecured loans because the lender has some security that they can potentially use to recover their costs (Source: MoneyAdviceService).
For this reason, it is common to see mortgages rates ranging from 1%-5% per year (Source: The Telegraph). This is compared to a payday loan which is likely to be above 1,000% APR or a guarantor loan that is around 46.3% APR.
Although secured loans may seem cheaper from the outset, secured loans are likely to come with arrangement fees such as broker and solicitor fees as well as asset valuation charges.
Both financial products allow for monthly repayments made up of capital and interest, repaid in equal or non-equal amounts. Payments are usually made through a direct debit account whether it is via continuous payment authority, direct debit or standing order. For small unsecured loans on the high street, the lender may also allow the individual to repay by cash or cheque.
Both types of products typically allow customers to repay early and doing so will be cheaper, as you are charged a daily interest rate. In the case of mortgages, it is common to make over-repayments because this will mean you loan is open for less time and will therefore be less to pay overall.
For some long term secured loans, there is a penalty for early repayment, which is typical for mortgages and less common for unsecured products.
The implications of non-repayment
The most important aspect of a secured loan is that your valuable asset can be repossessed if your loan is not repaid on time. For homeowners, the idea of being homeless is a very worrying prospect so lenders will always take appropriate steps to try retrieve their repayments – this may include sending notice letters, follow up phone calls and offering arrangements to pay.
Oftentimes secured loan providers will have a ‘grace period’ of a few days before they will take the appropriate action having not received a payment from you. It is always best to let a lender know in advance if you do not expect to be able to make a repayment.