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.
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
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 include:
- personal loans
- credit cards
- payday loans
- peer to peer loans
- wedding loans
- funeral loans
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.
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 and are only available to them because they have something that can put down as collateral.
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 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.
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, secured loans are likely to have arrangement fees such as broker and solicitor fees, that should be included in the APR.
Fixed or variable
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.
(Inset: for those of you who love a bit of A-Level Economics!)
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 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.