Are secured loans better than unsecured loans
When looking into your loan options, you’ve likely come across the terms ‘secured’ and ‘unsecured’. These will be used in relation to the types of loan you are applying for. Both secured and unsecured loans have their advantages and disadvantages, meaning there is not necessarily a ‘one size fits all’ answer to which is better. Each will come down to the type of loan you are applying for, the use of the loan and your own financial situation.
Each type of loan has its strong points, and is good for a specific reason or purpose. So there are benefits to each and every form of loan.
Payday loans, for instance, are easy to apply for and be approved for, so they are quick, and don’t require perfect credit.
Guarantor loans are quick and easy to apply for, and also do not require good or perfect credit, however, you can borrow more money, and pay it back over a longer period of time, making them affordable.
Both these types of loans have benefits, and fit a specific need.
With this in mind we’ve broken down the difference between secured and unsecured loans, and answered any questions you may have had about the two different types of loan, all aimed at helping you decide which is best for you.
What is a secured loan
A secured loan involves borrowing an amount of money and ‘securing’ it with a valuable asset such as a car or home. There is a risk of your security 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.
Lenders often feel that the potential repossession of goods is a strong incentive to make sure a borrower doesn’t miss a repayment.
Secured loan examples
An example of a secured loan is a mortgage. If you fail to pay the mortgage, which in this situation is the loan, then your house will act as collateral. Essentially this means that if you fail to pay off your mortgage, then your house can be repossessed.
Other examples of secured loans include:
- car loans
- logbook loans
- development loans
- bridging loans
- debt consolidation loans
- first charge loans/first charge mortgages
- second charge loans/ second charge mortgages
Benefits of a secured loan
A secured loan, as we mentioned poses less risk to a lender, so what do they offer us as borrowers in return, as a benefit?
- Lower Interest Rates: In most instances, a secured loan is going to have a lower interest rate or APR/annual percentage rate, than an unsecured loan. Since secured loans are less risk to a lender, they can charge a lower or reduced interest rate. Unsecured loans being a higher risk, will carry a higher interest rate.
- Extended Terms: The term of a loan is how long you are borrowing the money for and repaying the loan. Many unsecured loans may have terms of 12 months, 36 months, even 60 months (5 years). Secured loans can carry short terms such as these, but they can also have extended terms up to 10 years, or even longer depending on the type of loan and the loan amount. By extending the term of a loan, it reduces the payments. It also can increase the amount of interest you pay, as you are paying the loan over a longer period of time, but if the interest rate is lower, due to being a secured loan, it can offset some of this.
Potential downsides of a secured loan
Despite the benefits of secured loans, there are a number of downsides.
- Depreciating value of the collateral may make a secured loan less beneficial. I.e. a car does not appreciate in value, like a home does. This means you would need to balance the interest rate and term of a loan, to see if getting a personal loan to buy a car may be a better deal
- If you fail to make the payments, the item used as collateral can be repossessed. This could be your home, or car, or whatever else you’ve used as collateral.
- Secured loans may have hidden fees for late payments or early repayments.
What is an unsecured loan
By comparison, an unsecured loan means that you can borrow a sum of money without putting down any assets. Since you are not securing the loan with something valuable like your home or car, the amount you can borrow is less and the rates tend to be higher than a secured product.
Examples of unsecured loans
- personal loans
- credit cards
- payday loans
- peer to peer loans
- wedding loans
- funeral loans
Benefits of an unsecured loan
With all the benefits on offer from a secured loan, some may be wary of taking on an unsecured loan, however there are a number of benefits for unsecured loans that make it perfect for certain situations.
- Availability: unsecured loans are available for a large proportion of people, and without the need to secure them against collateral it doesn’t rely on you having high costs items.
- Shorter terms: While secured loans often have longer terms, unsecured loans are usually over a 3 to 5 year term.
- Payment holidays: Some loans may even offer a payment holiday in the first months, meaning you don’t have to start repaying the loan straight away.
Potential downsides of unsecured loans
Despite these benefits, there are a few things that are worth watching out for, which could potentially prove to be downsides.
- The interest on an unsecured loan, due to the nature of there being no collateral, can sometimes be very high, so keep an eye on this and make sure you can afford it.
- Your credit score could greatly affect your ability to get a good deal, which is where a secured loan with collateral, or a guarantor, may prove to be useful.
How a guarantor loan can help reduce monthly payments on an unsecured loan
Loans with a guarantor sit in the middle between secured and unsecured because on the one hand, they are unsecured with no collateral needed to be put down or at risk of repossession. However, you cannot be eligible unless you have some form of security (the extra person to be your guarantor) so this makes is secured to a degree. Hence, it kind of falls in the middle.
This means that it can keep rates lower than other unsecured loans, plus it offers the chance for people who may not normally be accepted for a loan to obtain one.
What are the criteria for a secured loan?
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, there are some products like logbook loans which are better suited for those with bad credit, rather than an unsecured loan and are only available to them because they have something that can be put down as collateral.
What are the criteria for an unsecured loan?
For unsecured lending, the individual should ideally have a good credit score or regular income so that they can repay their loan. The lender wants to see that the borrower has some financial stability and therefore should be able to make their repayments on time. If the applicant has a poor credit rating, they may increase their chances of being funded by adding a guarantor with good credit to their application or perhaps they will be charged higher rates to reflect the extra risk involved.
Secured & unsecured loan terms
Secured loans tend to have longer loan terms and for a mortgage, can last for 5,10, 25 or 40 years.
The term of any payday or unsecured loan will depend on the lender itself and each customer’s individual circumstances.
The cost of a secured or unsecured loan
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 mortgage 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, secured loans are likely to have arrangement fees such as broker and solicitor fees, that should be included in the APR.
Fixed or variable rates for unsecured or secured loans
Both types of loans can come as fixed or variable. Fixed means that the interest rate charged stays the same during the loan period and does not change whether it lasts a few months or several years. Variable means that the rates are subject to change over time due to Bank of England rates and other economic factors.
For secured lending and mortgages in particular, you can choose whether you want to have your loan fixed or variable – and you must be aware that if you have a variable loan that you could be paying less, or more, if the rates change.
Unsecured loans are often fixed and will only be variable if the lender decides to change their rates during the loan term.
The repayments for secured & unsecured loans
Both financial products allow for monthly repayments made up of capital and interest, repaid in equal or unequal 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 your 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.
In addition, not paying on time may also lead to a fall in the borrower’s credit score, added fees and difficulty obtaining finance in the future.
For unsecured loans, the biggest impact on failing to repay will most likely be to the individual’s credit score which may fall and make it harder to access affordable finance in the future. The loan vendor is also likely to charge added fees for late repayment such as a one-off default charge and interest for every extra day that the loan is not repaid.For more information, see what happens if you cannot repay your guarantor loan.
Repayments may help your credit score
If the borrower repays their loans on time, it may cause their credit score to improve or maintain a high level. The individual is able to prove their creditworthiness by repaying loans on time and this will make them a more viable borrowing prospect in the future. This is very common with guarantor loans whereby the main borrower typically has a less than perfect credit score but with the help of the guarantor, they are able to access a loan and build up their credit score by making regular repayments on time.
Compare Guarantor Loans
If you’re after a guarantor loan, we feature a number of the top guarantor loan lenders on our website, where you can compare the best ones available to you. As experts in guarantor loans we can help you find the best unsecured guarantor loans, using our guarantor loan comparison tool.