There are a wide variety of loans available to personal borrowers to suit different purposes and financial means, but these can all be boiled down into two essential categories – Secured, and Unsecured loans.
Secured vs Unsecured loans: What’s the difference?
A Secured loan means that the lender holds a valuable asset belonging to the borrower as collateral against the payments. Therefore, if repayments are not met, the asset can be seized from the borrower and sold to cover the cost of the missed installment. This is often the borrower’s house, but could also be a car or any other valuable item.
An Unsecured loan is, as you might have guessed, a loan that is not protected by an asset. The borrower is bound by contractual obligation, and may be met with late payment charges or could even find themselves in court should they fail to meet each installment.
Which loan is right for me?
The answer to this question lies in what you need a loan for, how much you need to borrow, how long you intend the repayment period to be, and the state of your personal finances.
Certain types of loan are by their nature secured, for instance Home Equity, Homeowner, and Car loans. This means that until purchase is entirely complete, the product remains in some respect property of the lender, and can be resold to cover their losses. This is really the same as any product – when you’re shopping, the item in your basket is not truly yours until you have checked out, and, should you find that you don’t have enough to pay for it, it can rightfully be reclaimed by the retailer so that their profit is not affected. Personal loans are often unsecured because factors of amount and term length are usually lower, so there is less risk to the lender.
Borrowing amounts
The amount you wish to borrow will affect whether or not your lender will require collateral. Unsecured loans are usually available up to £25,000, so if you require a relatively small amount of money for a short-term project, an unsecured loan may be useful. Amounts over £25,000 are usually secured because of the increased level of risk to the lender on offering money at that scale. They need the guarantee that they will be covered should you fail to repay them. However, Secured loans can also be taken out at costs as low as £3000, and up to £50,000 on average. Some lenders may increase to £100,000.
Loan repayment periods
Generally speaking, Unsecured loans have much lower repayment periods. Around the £10,000 to £25,000 mark, repayment term lengths may stretch to as much as ten years, but most are shorter, if only because the amount is usually much lower than with a Secured loan. Some lenders may also allow occasional over-payments (if, for instance, you found you had a little extra money one month) and lump-sum payments alongside the usual pre-determined fixed monthly payments. This is because, without the security of a secured asset, the lender wants their money back as soon as possible – the less time it is out of their hands, the less likely it is, in their view, to be lost. Interest rates tend to be much higher, calculated by your income and credit history, to ensure the lender is not left wanting. Secured loans, then, will normally have a longer repayment period because the collateral held by the lender allows them to relax slightly about their money – they know they will get it back one way or another. Payments are made in agreed monthly installments, and terms usually last between three and twenty-five years. Interest rates are also lower to reflect the longer repayment period. Therefore, Unsecured loans are suitable for short-term projects (for those with the money readily available to meet installments at least – see below), while Secured loans may be better for those who need money over a period of time, or who do not have enough income to pay off their debts in larger amounts.
Personal financial circumstances
Your personal finances, credit history in particular, will also have an effect on which kind of loan is most suitable for you. Because of the recession, lenders are becoming less willing to loan money to those with a poor credit rating, because this increases the risk to them. Where there is no security on the loan, lenders will normally set interest rates based on the borrower’s credit rating. They are therefore also likely to charge higher rates of interest on Unsecured loans for those with worse credit histories in order to recoup their money. Those with a poor credit history may find, then, that they are more likely to be accepted for a loan, and given a better interest rate once they are accepted, if they can offer an asset as collateral for a Secured loan. A Secured loan is also a more viable option for those who are self-employed, or who have recently changed jobs as both of these factors affect your desirability in the eyes of a lender.
Risk assessment
Risk levels should also be taken into account. What eases the mind of the lender works as a bane for the borrower – a Secured loan puts your home, car, or valuables on the line. If you fail to meet your repayments, you risk losing it. If you do not think you are capable of meeting repayments, it may not be wise to risk your property. Unsecured loans do not carry this level of risk, but failure to pay will still damage you financially – be it in affecting your credit rating, or hitting you with late payment charges.
Think carefully, then, before deciding which kind of loan to choose. Take into account all the above factors. For a small, personal, short-term loan (e.g. for funding a wedding, or a similar one-off expense), an Unsecured loan is probably the better option. Secured loans are much better for those who may have poorer personal finances, or who need a more substantial and on-going loan. The bank, building society or broker you take out a loan with will advise you on what is best for you.