What is the difference between secured and unsecured loans?
There are a variety of different borrowing options available, which can make choosing the right loan a daunting decision.
One of the main choices is whether to use a secured or unsecured loan, but what actually differentiates these funding options?
Fundamentals of a secured loan
Secured loans allow individuals to borrow a certain amount of money, over an agreed time frame.
A repayment plan will be implemented, to ensure the amount borrowed and the interest incurred is paid back. Repayments are usually on a monthly basis.
With a secured loan, an asset is used as security. Assets that are commonly used include properties, but some lenders will accept other items of significant value.
This means that to qualify for a secured loan, you must be either a homeowner or have another valuable asset to use. Secured loans secured against properties are also known as second charge mortgages as borrowers typically already have a (first charge) mortgage in place which was used to purchase the property.
By using a property as security, it means that if you consistently fail to meet monthly repayments and are unable to agree on an alternative repayment strategy with your lender, then just like with a first charge mortgage, your property may be repossessed.
Individuals could therefore lose their property, and so it is particularly important for them to carefully consider how much they can afford to borrow and repay, prior to taking out a loan.
Basics of an unsecured loan
Unsecured loans do not use any assets as security, meaning that a set amount of money is borrowed from a lender, without any collateral needed to secure against it.
Lenders will instead rely predominantly on the borrower’s credit rating and their agreement to repay the loan.
Many individuals therefore consider unsecured loans to be more flexible, comparative to secured loans.
However, lenders often see unsecured loans as a higher financial risk, due to the fact that nothing has been used as security. Consequently, interest rates can be higher on this type of loan, compared with secured loans, to mitigate this risk.
With an unsecured loan, lenders cannot repossess an asset if an individual defaults on their repayments. Instead, they can seek alternative methods to get their money back, including issuing county court judgements.
A county court judgement can be particularly damaging to your credit rating, which could hinder your success at securing future loans.
Therefore, although your property may be safe, there are still risks involved with this borrowing option, meaning that you should assess your personal situation thoroughly before applying for either type of loan.
Key differences between secured and unsecured loans
The primary difference between secured and unsecured loans is that one uses an asset as security, whilst the other does not.
There are however a few other key differences between these loans that are worth noting.
First, secured loans typically allow individuals to borrow a larger sum of money, with a lower interest rate, as the asset used to secure the loan reduces the financial risk to lenders. However, this is dependent on other factors related to the person’s circumstances.
In comparison, unsecured loans tend to allow a smaller amount to be borrowed, with a higher interest rate, due to the fact that lenders are taking on a greater risk by not asking for an asset as security.
Secondly, secured loans, are available over longer terms, ranging from five to thirty-five years, enabling borrowers to achieve lower monthly repayments compared to unsecured loans which are typically available over one to ten year terms. However, while a longer term can make for a lower repayment it will also mean that you will pay back more in interest in the long run.
Thirdly, unsecured loans generally require less paperwork and can pay out out very quickly, potentially in a matter of days. Whereas, secured loans, being mortgages against property, generally require more paperwork to be completed and typically take longer to pay out. This is where using a reliable broker can be an advantage. Brokers can help process your application and provide mortgage advice by assessing your needs and circumstances in order to recommend a loan that is suitable for you.
Which loan may be suitable for you?
A suitable loan is one that meets your specific borrowing requirements, and so the right loan is dependent on your personal circumstances.
Some individuals however may not be eligible for a secured loan if they do not own a property, and so an unsecured loan may be the most appropriate option for them.
On the other hand, a secured loan may be a better fit for those individuals who do have a property and who need a substantial loan to cover their borrowing requirements.
Before getting to the stage of applying for a loan, it is important for individuals to assess their personal circumstances carefully in order to determine the best course of action.