Secured and unsecured loans

If you are thinking about taking out a loan, you may be wondering about the differences between secured and unsecured loans.

Which would apply to your circumstances may be determined in part by a number of factors including:

• how much you want to borrow;
• whether or not you are a homeowner.

Unsecured loans

Unsecured loans are typically based on your credit rating plus your income and are commonly used for things like:

• debt consolidation;
• DIY projects;
• or perhaps a new car.

The amount of interest that you pay on an unsecured loan is based on how risky a proposition your lender perceives you to be based on your credit rating.

If you default on an unsecured loan, the lender may take recovery action but this does not necessarily mean that you would lose your home. You do not have to be a homeowner to take out an unsecured loan.

Secured loans

A secured loan is one where the loan is guaranteed by one of your assets. The most common asset used as security is your home and secured loans may sometimes be known as homeowner loans. Certain types of car loan may use the car as the securing asset.

For many lenders, if you do not own your property it is unlikely that you would qualify for a typical secured loan.

Secured loans tend to be for larger amounts of money where the lenders may feel that their risks are high and so want to guarantee that, in the event of something going wrong and the repayments stopping, they have a valuable asset that they can use to offset their losses.

The most common type of secured loan is probably a mortgage and your lender will hold the deeds or your property until your mortgage has been paid off.

The amount you could borrow with a secured loan based on your home may be determined in part by the amount of equity you have in your home.

The equity is the amount of money that you would have left over if you sold your house and paid off your mortgage.

Any further loan secured on your property would have to be paid off using the remaining equity.

If the value of your home were the same as the outstanding mortgage then, in theory, the sale of your property would only cover the balance of the mortgage.  There would be no money available to repay any other loan.

So in addition to being a homeowner to qualify for a secured loan, you would typically also have some equity in your property.

Using a loan calculator to help work out your budget

Many of the major banks offer extensive online banking facilities, including the ability to arrange loans. They may also offer an online loan calculator to help you understand how a potential loan could affect your monthly budget.

The first thing you need to decide though, is how much you want to borrow and for how long.

The cost of a loan

An important point to remember is that there is a direct relationship between how long you have the loan for and how much interest you’ll have to pay

With a loan taken out for 5 years, for example, you may typically pay less in interest overall than if you opt for a loan of 10 or 8 years.  However, the monthly instalments for a 5-year loan will be higher than if you borrow the same amount of money over a longer time frame.

So if you can choose the length of time you want to have the loan for, then you have to weigh up whether you prefer:

• to pay the loan back as quickly as possible to keep the overall cost down;
• or to get a lower monthly repayment at the expense of paying more in interest over a longer period of time to the lender.

A typical loan calculator like the ones supplied by the online loan providers should help provide you with the information you’ll need to make your decision including:

• the monthly repayment instalment;
• the typical Annual Percentage rate (APR);
• the total amount payable.

You can obviously input different loan amounts and time periods and compare repayment schedules.

Can you afford your loan?

Once you have the monthly repayment figures, you may be able to go one step further with the loan calculation and see how the loan would work out for your monthly budget.

It’s not just a question of keying in your income. You also need to be fairly accurate with your expenditure to get a realistic idea of whether or not you can afford the loan repayments.

When planning your budget, remember to include all aspects of your income - for example:

• wage or salary;
• income from properties and investments;
• other benefits.

Expenditure figures will include things like:

• rent or mortgage;
• childcare costs;
• food  travel and utilities costs;
• maintenance payments;
• other loans.

Some loan calculators can estimate some of these elements based on the structure of your family (number of dependent children etc.).

Armed with the information supplied, you can then decide whether or not you want to proceed with the loan.

A final point to bear in mind is that the figures provided by a loan calculator are useful as a guide for information only. Final figures will only be given once you have completed a loan application and following a credit check.

Why can’t you get that low rate loan?

Sometimes it seems difficult to reconcile the loan advertisement figures with the figures you’re actually being quoted. Whatever happened to that low rate loan?

Loan rates

It’s not unusual to see a headline interest rate for a loan and alongside it a little asterisk.

Somewhere down on the small print it will have the notes that relate to the asterisk and you may find that they say, to all intents and purposes, that the quoted rate is only available in certain situations and is based on the ‘typical’ customer.

If your particular circumstances don’t meet that type of situation, then you may end up paying more than the advertised rate.

Conditions

Those conditions may be varied and lower rate loans may only apply to:

• secured loans where your loan is being guaranteed by one of your assets – say for example your property (in practice, it may be difficult to obtain an unsecured loan unless you have an excellent credit history and they may prove to be more expensive);
• loans above a certain value;
• loans which are linked to having an existing account or opening one;
• etc.

This isn’t a comprehensive list and there may be a number of reasons why that low rate loan advertisement may not apply in your case.

Secured versus unsecured loans

As touched on above, lenders set their prices based on several factors, one of which is their perceived risk.

A secured loan (or one underwritten by a guarantor) is lower risk for the lenders and you may, therefore, benefit from a reduced price.

Undertaking to secure your loan may be interpreted as a sign of your confidence that you’re going to pay in back in a reliable and orderly fashion – and that’s what many lenders like to see.

Of course, before securing any loan on your home itself, you should be absolutely certain that you can afford it and will be able to repay it back on the basis you commit to as part of the loan agreement.

If you do not, you may risk losing your home or the asset you used to secure the loan.

Do the maths

So, don’t be too swayed or frustrated by those low rate loan offers.  Look around, think about your options and above all, do your sums.

Some common questions about loans

Researching loans may be a little daunting, especially if you are not used to taking out financial products. Accordingly, you may wish to look at the answers to the following questions to help you feel more informed about loans.

How much do you need to borrow?

The first thing you may wish to establish is how much you need to borrow. Are you borrowing the money for a particular purchase like a car or to spend the money on an educational course? If the loan has a particular purpose, you may find that lenders may offer dedicated products for this (eg car loans).

The amount that a bank or building society may lend you may depend on:

• your credit record. If you have lots of missed payments, CCJs and insolvency problems on your record, you may find it more difficult to get credit than people without such problems on their credit history. However, you may wish to check your credit history before you apply, because credit records can sometimes contain mistakes. (Contact Experian, CallCredit or Equifax – these are the three main credit referencing agencies in the UK and you’ll typically be able to get a copy of your file from one of these for a small fee);
• your income. Lenders may look at how much you have coming into your bank account when they decide whether to grant loans, and how much to lend you; and
• your commitments. In addition to looking at how much money you have coming in, lenders may also assess how much of that income is already committed to service existing debts and pay necessary bills.

How much will the loan cost you in interest?

This is a question of looking at the APR (annual percentage rate), which takes into account the total costs of the borrowing and expresses it as a percentage of the loan. So this takes in any fees that may be payable for the loan in addition to the interest rate itself (but not other fees, such as charges for things such as missed payments).

Getting an online quote

You can get no-obligation quick online loans quotes from many providers online which may give you a better idea of what is a sensible amount to borrow.

Note that these are only rough guides and if you make a loan application, you may find that the monthly repayment rate may differ.

Can you really afford the repayments?

Finally, do ensure that you will comfortably be able to afford the repayments. Even if a lender approves you for a loan, you may wish to take a long hard look at your monthly budget to decide whether getting loans is affordable for you.

Varieties of loans

If you’re looking for loans, you’ll find that there are a lot around to choose from.

Qualifications

However, before you even start you’ll need to think about the typical sorts of things you’ll need to have to qualify.

This will depend very much upon the amount you wish to borrow but typically:

• a loan may be hard to find if you are unemployed or have a poor credit history;
• ditto if you already have large borrowings in relation to your earnings (sometimes called your debt-to-income ratio);
• some providers may view certain categories of self-employment or part-time working as being cause for concern.

Types of loans

Broadly speaking, lending breaks down into two categories:

• secured – typically your borrowing is secured against an asset that the lender may seize (or get a court order to make you sell) in the event you don’t pay the loan back;
• unsecured – typically advanced purely based upon the lender’s perception that there is a small risk of you defaulting.

Typically, for larger borrowing, unsecured lending is a little harder to obtain than secured and it may sometimes cost you a little more in interest compared to a secured loan.

Costs

The costs of borrowing vary hugely depending upon the provider you use, the amount you’re trying to borrow, your personal circumstances and the purpose.

Shopping around for loans is, therefore, typically advisable.

Finding loans

Many of us use loans perfectly responsibly for things such as car or house purchases, holidays and so on.

In fact, assuming you have the income to service the loan appropriately, sometimes a loan can be a cost-effective way of using money.

Lending today comes in a multitude of forms. One important major distinction to begin with is:

• secured;
• unsecured.

An unsecured loan basically means that the lender has no direct security over one of your assets in the event you default. By contrast, in the case of a secured loan they do – and that asset is often your home.

Typically, a secured loan may be a little cheaper than an unsecured loan but keep in mind that any asset you use to secure a loan may be at risk of seizure if you are unable to keep up payment of the loan.

As a general rule, the longer the period you take out your loan for, then the more it will cost you over the full term.

Although it’s risky to generalise, typically lenders will tend to look more favourably on applications for loans for an asset acquisition or enhancement (e.g. houses, cars or property extensions) than they will on applications for expense items such as holidays or clothes etc.

Looking for a loan

If you need a loan, for whatever purpose, then you may be not just looking for money but also a product that’s suitable for your situation.

Your situation is unique to you and a product that’s right for one person won’t necessarily be suitable for another.

Your situation

When thinking about loan products, you might start by asking yourself a few questions:

• do you want to offer security – in other words, will you be willing to guarantee your borrowing by linking it to an asset such as your house;
• how long to do you want to repay the money over – longer repayment periods typically will reduce your monthly repayment amount but they’ll increase overall the amount you have to pay back;
• how much do you need to borrow – remembering that this will need to make sense against your earnings and ability to repay it;
• why do you want the advance – advances for asset purchases such as houses and cars may be more easily obtained than those for consumables such as clothes or holidays.

Being clear about these things is important because you’ll typically find that there are types of lending in the market that are specifically aimed at these factors (and many more).

The cost of borrowing

How much you have to pay for borrowing money will vary depending upon a number of factors – including the answers to the above questions.

Today, the advances offered by major providers will typically cite the typical APR (Annual Percentage Rate) to show the cost of your borrowing.

Typically, the lower the APR then the lower will be the cost of your loan, all other things being equal.

It’s maybe worth noting though that some providers may also make additional servicing or administration charges. By law, this must be highlighted but if charged, then they will increase the overall cost of your borrowing. You may not be offered the ‘typical’ rate if your financial profile doesn’t fit that of a ‘typical’ customer.

Borrowing and debt

Debt may be essential if we’re to purchase major items such as houses, conservatories, cars and furniture.

Used responsibly, borrowing can be perfectly manageable and millions of people manage to use capital in this way without getting into debt problems.

Your ability to comfortably repay your borrowings on a monthly basis is called servicing your debts. Most responsible lenders will happily use various forms of income and expenditure modelling to help you understand approximately how much you could borrow and safely repay. Some offer online loan tools to help you get a rough idea of affordability; what your repayments may be etc.

It’s typically a good idea to incline towards conservatism when doing these sums.

Given that bad luck can hit anyone, it may be worth considering one of the various forms of loan or income protection insurance policies. Once again, the major financial companies will typically be only too pleased to offer further advice on this subject.

Loans explained

Borrowing money is something done by many households simply because some of the straightforward items available to us are too expensive to pay for up front. In fact, lending is the only way in which many things like cars are obtainable for ordinary people. But not fully understanding how loans work can be disastrous, as the more they get out of hand, the harder they tend to be to deal with. Choosing the right product is the first step towards managing your debt comfortably.

Loans are available from banks, building societies, and specialist companies. All involve an amount of interest, as that is how the firm itself makes money on giving up cash. Some might include interest free periods, usually in the first few months of the loan, but some way or another you will end up paying back more than you have borrowed.

The two main loan types are secured and unsecured. Secured loans are normally more associated with larger purchases and are often quite quick to arrange. For example, someone might borrow 18,000 pounds from a bank to help finance a home extension. They can also be spent on new cars or even to fund someone’s higher education.

This ’secured’ part of the deal involves the borrower offering up some form of collateral as proof that they are going to pay back what they owe. This usually involves someone’s home, meaning it can be repossessed from them if they fail to keep up with the repayments. In this sense their house is acting as security for the bank or lender as an assurance that they’re going to get the money back. The plus side of this is that it can help someone to get a large amount of money, but the downside is that if someone fails to keep up with it, they can eventually lose the roof over their head.

The availability of secured borrowing is linked to house prices, the more prices tend to fall, the less secured loans can be available. This is because banks become concerned that the effective value or strength of the security someone can offer is unstable and may be decreasing.

Unsecured borrowing, although it might sound somewhat unstable and risky, actually involves the borrower and not putting up any asset. As a consequence they are usually only granted for smaller amounts and attract higher interest rates. Because a loan is unsecured does not mean you can get away with not paying it back. Banks can still take legal action through the courts and can refuse to lend you any more money in future. You’re also likely to end up with a significant mark on your credit rating, significantly affecting your ability to borrow and even open up and run bank accounts in future.

A vast array of different interest rates are available from different providers, and these can fluctuate wildly. Of course the interest rate is the key to how much you are going to pay back overall, so it may seem that the smallest possible interest rate means that product is the best possible deal. But it can pay to look carefully at the payment plans of different loans, and particularly at any low or no interest free introductory periods. Once you come off this introductory rate the interest may switch to a very high level, negating what you otherwise would have saved - so it can pay to look carefully at the small print.