The two most common types of finance available in the mainstream UK lending market are secured and unsecured loans. Both of these types of finance can serve distinct purposes and used correctly, either type has the ability to improve businesses, tide borrowers over until their cashflow increases and even help a business start up by providing much needed short term funding.
There are a multitude of secured loan options with some of the best-known and most utilised including the likes of auction finance, bridging finance and even mainstream mortgages, all of which are secured against a high value asset [property] as security on the loan. Guarantor loans are also a type of secured loan as they require a guarantor to act as the security for the borrower. Hence, if the borrower defaults, the responsibility falls upon the guarantor, having agreed to cover any shortfalls.
Unsecured loans and finance also come in various guises with common types being payday loans, instalment loans and even mainstream business loans which do not utilise anything as collateral for the loan in question. This increases the amount of risk to the lender and therefore, the interest and fees associated with these types of loans tend to be higher than for secured equivalents.
Common Types of Secured Loans
With the UK being a nation of property owners, unlike many countries in Mainland Europe and around the world, there are increased opportunities to take out secured finance with a number of common and widely utilised loans available on the market. Whilst guarantor loans are a common type of secured loan, property tends to be the highest value asset that loans are secured against.
Traditional Mortgages – These are likely to be the first major loan most people take out in their lifetime and are often an indicator of one of the most exciting times of the borrower’s life; purchasing their own property. The way these widely used loans are structured starts with the borrower finding a property they wish to purchase. Subject to valuations and their deposit [down-payment], they approach a bank or broker to arrange a mortgage. The deposit will cover a proportion of the property’s value (its equity) and the mortgage will cover the rest with interest added.
For example, a buyer finds a property for £500,000 that they wish to purchase as their place of residence. They have £200,000 in savings which goes towards the first portion of equity in the property. Then, they approach a bank for a mortgage of £300,000 to cover the outstanding value, repaid over a period of 20 years with interest added on top. The interest may be at an agreed fixed rate or may be dictated by the Bank of England’s base rate.
Bridging Loans – These loans tend to be used when a current homeowner is looking to move property but there is a ‘break in the chain.’ This means that a part of the sales process falls through even after finding a buyer and having found their new property. rather than having to forfeit on their preferred new property and likely their deposit too, a bridging loan can be sought. These loans work by bridging the gap between purchases.
For example, a homeowner is looking to upsize to a larger property for their growing family. Their current home is valued at £500,000 and the new property is valued at £700,000. Typically, they would sell their existing property, use the sales amount towards the new property, with the rest of the balance being covered by refinancing [mortgaging] the new property for the outstanding amount.
However, in the case of a bridging loan, the homeowner can acquire a loan to cover the full purchase amount of the new property until they sell their initial property. This is known as the ‘exit process;’ the process by which they will exit the loan. Upon finding a buyer for their initial property, the money goes towards the bridging loan, with the remaining amount and interest being paid off by securing a mortgage on their new property.
Logbook Loans – Another high value asset is a vehicle ranging from £500 to £50,000. A logbook loan secures a loan amount against the V5 document of a vehicle. With the V5 being the document of ownership, should the borrower default on their repayments, the lender can seize their vehicle to recoup any losses. Furthermore, the borrower cannot borrow the full value amount of the vehicle. This means for example that if a borrower secures a logbook loan of £5,000, their vehicle will likely need to be worth more than around £7,000.
Unsecured Loan Types
Unsecured loans tend to be for smaller amounts than secured equivalents. This is mainly due to the fact that they are of increased risk to the lender who will find it difficult to recover any outstanding loan amount should the borrower default, with no assets of value being security for the loan. Some types of unsecured loans are more common than others:
Payday Loans – These are one of the most popular and widely used types of secured loan available. The way these loans work is by the borrower applying with a lender to borrow an amount of money, usually up to around £2,000 over a predetermined time period (a month or so). These loans will usually be used to tide borrowers over until their next payday, at which time they will repay the payday loan plus interest. The downside of these loans is that due to their very short term nature, should a borrower miss their repayment date, there are various late fees and additional charges that can make it yet more expensive.
Credit Cards – These are the most widely utilised form of unsecured credit, used by millions of people in the UK on a daily basis. Credit cards work by the ‘borrower’ applying for a credit card with a credit limit. They are then free to spend on the card each month until the credit limit is reached. The balance must then be paid off. If the balance is cleared at the end of the month in full, then no interest is paid and the borrower returns to ‘zero’ at the start of the next month.
Personal Loans – General loans that are unsecured are known as personal loans. This assumes that the criteria for the loan is based on your credit history and affordability. Whilst quite broad, personal loans can include short term loans, wedding loans, funeral loans, emergency loans and loans for any purpose that do not require any form of collateral.
However, if not all of what is owed is repaid or if just the minimum payment is made, then interest is added to what the borrower owes and this can add up to potentially far more than the actual amount spent in the month in question.