Secured Loans Vs Unsecured Loans.

Loans will in general come under one of two categories – those that are ‘secured’ and those that are ‘unsecured’.

This distinction relates to whether or not a lender wishes to take security or ‘a charge’ over something of the borrower’s in order to reduce their risks when lending. Secured loans are usually required when the item being purchased is of high value and the repayments made over longer periods.

In principle a secured loan means that the borrower will take the loan and offer the lender a guarantee that if the loan is not paid off when promised, then the lender will have legal right to take possession of a specified item of the borrower’s and do with it what they will.

This may sound a little complex but this type of this lending has been with us for centuries.

In a classic pawnbroker operation the pawnbroker will take a precious item and make a loan based on their assessment of its value. Although slightly different in that the pawnbroker holds the security physically for the duration of the loan, if the borrower fails to repay the loan within a specified period then the pawnbroker has the legal right to sell the item and recover the loan from the proceeds.

The purchase of a high-value piece of jewellery may work in a similar fashion. A loan would be taken out for the purchase and although the purchaser would in this case have the item in their possession from purchase, if they subsequently failed to maintain the loan repayments then the lender would have the right to seize the jewellery and sell it if necessary.

Another form of familiar ’secured loan’ is the standard mortgage. In this the lender will advance a sum to help purchase a property. As part of the legal details of the sale/purchase, the lender will have the right to repossess and sell the property should the borrower default on the agreed payment schedule.

There does not necessary have to be a direct link between the purpose of the loan and the security. For example, it may be possible to obtain a business start-up loan that is secured against a house or other asset. If the business fails and the repayments cannot be continued, then the asset used as security will be at risk of seizure and sale.

In the case of a secured loan, typically the lender will advance a percentage of their perceived value of an item and rarely more. In that fashion, with a car loan for a vehicle priced at £15,000, the lender may advance only a maximum of say £12,000 because this is what they may think the car will probably be worth if the lender defaults in say 12 or 18 months time.

The one significant exception to this are mortgages where, until the recent economic crisis, loans may have been available for 100% or even up to 125% of the valuation of the property – due to the lender’s assumptions relating to house price increases year by year. This practice has proven controversial and it is now almost impossible to obtain these high percentage advances.

By law any lender advancing a secured loan, whether secured on the item being purchased or any other form of security such as a property, must make this explicitly clear to the borrower.

Unsecured loans are, as the name suggests, loans that are not secured against any specific property or item. The lender will perform a credit reference check on the borrower and will consider whether the loan amount makes sense against the purpose. These types of loans are usually for lower amounts and as a result, the lender feels that they can accept the risk of lending without asking for a legal charge of security to be put into place.

Even with unsecured loans, unless the amount is very small, it will probably be necessary to provide proof of purchase and again, the lender may require some contribution from the borrower by way of ‘deposit’.

Secured loans may offer lower interest rates than unsecured, as the amounts are higher and sometimes the risks are lower for the lender.

It should be remembered that even with unsecured loans, if a borrower defaults on loan repayments then a court might order the seizure and sale of property to provide for the settlement of such debts.

Always check carefully the conditions of any loan taken out whether secured or unsecured.

• Secured loans are where the borrower has offered the lender a guarantee against a ‘security’ – this may be the item purchased or another item such as property.
• Unsecured loans are usually given for smaller amounts where the lender is prepared to take the risk without formal guarantees.
• Secured loans are usually for higher value amounts paid back over longer periods – they may offer lower interest rates than unsecured loans.