Secured and unsecured loans: what’s the difference?

A loan can be a big financial commitment. By taking one out, you will be required to give up a portion of your salary every month until the loan is paid off, and failing to do so could result in serious consequences.

There are two main types of loan: secured and unsecured. Each have their advantages and disadvantages, depending on a) your financial health and b) how much you want to borrow.

Secured loan
If a loan is ‘secured’, it means it is secured against something you own (an ‘asset’) – and failing to repay the loan could result in the lender taking possession of that asset, and selling it to cover their losses.

The asset in a secured loan will normally be your home, but it can also be your car or another item of a high value.

Advantages of a secured loan

• It’s usually possible to borrow more than with an unsecured loan. It’s also possible to spread payments over a longer period of time. Since the lender knows they have your asset as backup, there is much less uncertainty about whether they are going to get all their money back.
• For the same reason, interest rates are often lower.
• Even if you have a bad credit history, you may be able to get a secured loan. Your secured asset will reassure lenders that they are able to get all their money back. However, if you currently have other debt problems, taking out further loans of any type could be a bad idea.

Unsecured loan
An unsecured loan does not require you to secure anything against the loan – the lender relies on your contractual obligation to pay it back.

Because there is no security and the risk they are taking is therefore greater, the amount you can borrow tends to be less, and the repayment period is usually shorter.

The lending criteria also tend to be tighter: lenders generally charge a higher interest rate which is determined mainly by your credit history and level of income.

Advantages of an unsecured loan

• Preserves the equity in your property and avoid the risk of losing your home or assets. Lenders are not entitled to repossess your belongings if you struggle to make your payments – although they can attempt to pursue this in court if necessary.
• You don’t need a property or any other expensive assets to take out an unsecured loan.
• It’s cheaper than credit/store cards for smaller purchases. Credit and store cards usually have very high interest rates, so if you’re planning on repaying over a few months, you can save a lot of money by taking out an unsecured loan to fund your purchase.

Tags: types of loans, secured loans

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