Guide: Unsecured vs secured loans

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Guide: Unsecured vs secured loans

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Introduction

Once you have decided to take out a loan, you must then choose whether or not you want or need to secure it against your property.

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Banks and other lenders are often more willing to give you a loan if it is asset backed – especially if the amount you want to borrow is over £25,000. But beware: your home could be at risk if you miss payments on a secured loan.

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What are the main differences between unsecured and secured loans?
Advantages and disadvantages
Which is most suitable for me?
Are there any alternatives?

What are the main differences between unsecured and secured loans?

Loans secured against a property that is already mortgaged are known as second charges, whereas loans secured against a property owned outright with no existing mortgage in place are known as first charges.

Until recently, loans of this kind were often seen as an expensive last resort for those unable to borrow without offering security. One of the main reasons for this was that they were only available through brokers who charged large commissions.

Banks and other lenders are often more willing to give you a loan if it is asset backed

Cheap, unsecured loans are also becoming harder to come by. As a result of the credit crunch lenders are more selective about who they will lend to and certainly those with a less-than-perfect credit history may find they are offered a more competitive rate if they are willing to secure their property against their debt.

Consequently, secured loans are becoming a more viable option, especially if you want to secure a large amount over a long period of time.

That said, for those wanting to borrow smaller amounts over shorter periods, an unsecured borrowing arrangement may well prove the right choice.

Secured loan conditions have become less draconian and easier to understand, but the terms attached to loans of this kind are often more onerous than those for unsecured borrowing.

Remember too that the amount you can borrow, the term available and the interest rate you pay will all depend upon the equity you have in your property, the lender's view of your ability to repay the loan and your personal circumstances.

Advantages and disadvantages

Unsecured personal loans are available for a range of different amounts and repayment terms. Larger loans such as those for over £10,000 can usually be taken over longer terms, for example between seven and 10 years, and the maximum you can borrow this way is about £25,000.

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Some lenders offer flexible loans which permit over-payments and lump-sum payments, both of which allow you to clear the debt over a shorter time period than first agreed.

With secured loans, the amount available usually ranges from £3,000 to £50,000, although some lenders will consider lending up to £100,000. Similarly to unsecured loans, the amount borrowed is repaid monthly over a term agreed at the outset, which will usually range between three and 25 years.

However, it is vital to keep up the repayments as all lending secured on your property could result in the loss of your home if you fall behind.

Some lenders offer flexible loans which permit over-payments and lump-sum payments

There is no risk of this with an unsecured product, but it is worth remembering that any failure to pay on time will adversely affect your credit rating, making it harder to borrow in future. You are also likely to be hit with late payment charges.

Before deciding how much to borrow, you should therefore check your monthly incomings and outgoings to ensure that you will be able to make the repayments.

If you are borrowing in order to consolidate existing debts, it is also crucial to pay off all your creditors once you receive your loan and to close the accounts. Otherwise you may be tempted to build up more debt again.

Which is most suitable for me?

If you are self-employed, have recently changed jobs or have a less-than-spotless credit history, you may find that you have no choice but to opt for a secured loan.

If you are self-employed, have recently changed jobs or have a less-than-spotless credit history, you may find that you have no choice but to opt for a secured loan – as long as you are a homeowner of course.

Secured loans are also useful for larger amounts or where the applicant requires a longer repayment period.

Otherwise, an unsecured arrangement should suffice.

Are there any alternatives?

If you are only looking to borrow a small amount, say a few thousand pounds, a credit card could be a good option. There are a number of deals offering interest free periods on balance transfers and purchases, making borrowing on a credit card potentially cheaper than a loan. It is worth noting however, that most providers charge a balance transfer fee, typically between 2% and 3%, if you move a debt over from another card.

If borrowing on credit cards, you should also be careful about using the card for different purposes. Most card providers apply a repayment order, whereby the cheapest debt is cleared first. So, unless you opt for a card that offers an interest-free period on both purchases and balance transfers for the same length of time, you should not use your credit card for both spending and a debt transfer.

If you are a homeowner and are looking to borrow more than a couple of thousand pounds, another option is to remortgage and release some of the equity from your house.

The fact that mortgage rates are generally lower than loan rates has made this a popular choice in the past, but there are disadvantages: Not least of these is the cost involved in increasing your mortgage or changing your mortgage provider. This now averages out at about £1,100, while some people pay up to £2,000 to make the switch.

There are a number of deals offering interest free periods on balance transfers and purchases, making borrowing on a credit card potentially cheaper than a loan

Secured loans are also likely to work out cheaper than remortgaging for homeowners who face stiff penalties to exit short-term, low-rate deals. If, for example, you are three years into a five-year deal, you could have to pay 10% or more of the total amount borrowed – or £20,000 on a £200,000 property – to change the terms of your mortgage.

Mortgage lenders are also tightening their belts in the wake of the credit crunch, meaning that low-cost remortgage deals are becoming much harder to find.

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