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.

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.

Secured loans v unsecured loans

There are times in everyone’s lives when things would be made much easier if they could get their hands on a large or significant amount of money. Borrowing money could be a solution to a situation like this when it arises. The main two ways of borrowing money are through secured loans or unsecured loans. Borrowing money from a lender is mostly considered to be a normal and established way of buying things that you would not otherwise have the money for.

If you find yourself in a situation where you want or need money to borrow, you will have to look around at the various loan options available to you. It is a good idea to try to remember that different lenders will require you to meet differing criteria. So if you are turned down by one bank, that doesn’t mean that you will get declined by another bank. However, repeated applications for loans can flag up a warning sign to lenders who will look at your credit file when accessing your suitability for a loan, so do bear this in mind.

If you need a relatively small amount of money, you could try to get an unsecured loan. For larger sums of money, you will probably be required to apply for a secured loan.

Applying for secured loans

• Establish how much money you need to borrow
• Do you have a good credit record?
• Will you use your own bank or another?
• Apply for the loan

An unsecured loan is a loan that is given to you without any security. This means that the lender has a limited number of ways of getting their money back if you failed to pay back the loan. This is as opposed to a secured loan that will be given to you against a valuable item that you own, such as your home.

When it comes to getting an unsecured loan from a bank or a lending institution of some kind, the only way for this to happen is if you have a good credit record. If you have bad credit and have showed signs of not being reliable in paying bills in the past, you may find that your only options for money are secured loans.

Secured loans are loans that are taken out against a major asset, such as your home. If you fail to pay back a secured loan, then included in the agreement is the condition that the lender/creditor has the legal right to take possession of your home for the use of recovering the money that they have lent you. A secured loan is usually considered to be more flexible, letting you borrow higher amounts of money than an unsecured loan, due to the fact that the lender has some security in getting his money back if you defaulted on repayments. In addition to this, most people can qualify for borrowing much higher amounts of money with a secured loan than with an unsecured loan.

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.