With so many options on the market, taking out a loan can be bewildering – especially as a first-time borrower.
Loans aren’t so complicated once you understand the key concepts, however – but one thing you definitely do need to grasp before you take one out is the difference between secured loans and unsecured loans.
All loans, whatever you’re using them for, are either secured or unsecured, but there are major differences between the two varieties. This guide will explain what you need to know about both types, so you can make an informed choice when you come to apply for a loan
What is an unsecured loan?
Unsecured loans, also known as personal loans, are the more common of the two types of loan.
They allow you to borrow a moderate amount – anywhere from around £1,000 to £25,000, though you’ll typically find the best rates for sums of between about £7,500 and £15,000.
Unsecured loans tend to be offered to people with decent credit scores, those who seem most likely to be able to make their repayments on time and in full. This is because banks lend according to the amount of risk a borrower poses, and the better your credit score, the more reliable you look. That’s why the best rates of interest are usually offered to people with the best rating.
Most importantly, an unsecured loan does not require you to put up collateral – usually your house or perhaps your car – as a guarantee to the lender that you will be paying them back.
What is a secured loan?
A secured loan on the other hand, sometimes referred to as a homeowner loan, links the debt to the borrower’s property. While technically a loan of this type can be secured against any kind of valuable collateral, such as a car, they are mostly taken out by people who own a home, and can be used to borrow much more significant sums of money.
Lenders tend to offer more money and better rates on secured loans because they have the security of knowing they can reclaim the value of the loan if you default. In effect, this means better rates of interest, longer repayment periods and higher maximum sums.
However, the amount you can borrow, the duration of the loan and the interest rate you are offered will all depend on your personal circumstances and the amount of free equity you have in your property.
Free equity is the difference between the value of your home and the amount you owe on your mortgage, if you have one.
What to consider before taking out a loan
Because everyone’s circumstances are different, there are no hard and fast rules over which type of loan is better for you. However, there are a few simple things you should consider when you look to apply for a loan:
- Eligibility: How good is your credit score, and how will that affect your APR offer?
- Amount: How much do you need to borrow, and is it more than you’re likely to be able to secure with a personal loan?
- Risk factors: Is your need for a loan worth the risk of putting up your home as collateral, and are your circumstances sufficient to pay it back?
The pros and cons of unsecured loans
- Flexibility: Unsecured loans let you choose how long you have to repay them, with most borrowers making fixed repayments for between one and five years
- No collateral: You aren’t borrowing against the value of your home, meaning that it’s not at risk if you default on the loan, although your credit rating and ability to borrow in future will be
- Less to borrow: Unsecured loans let you borrow less than secured loans
- Higher rates: Interest charges on unsecured loans tend to be higher than those on secured loans, because they aren’t backed by collateral
- Credit dependant: The best loans are only open to those with high credit scores
- Expensive in the short term: Personal loans tend to charge higher rates of interest the shorter they are, making them a poor choice if you want to borrow for a year or less
The pros and cons of secured loans
- Borrow more: Secured loans are available for much larger amounts than personal loans, which generally only go up to about £25,000
- Available to more people: Secured loans are often the only option for people with a less-than-perfect credit history. As your property acts as security, they can be easier to qualify for
- Longer repayment periods: Repayment periods on secured loans can also be longer, while the fixed monthly payments should make it easy to manage your repayment plan
- You could lose your home: The main disadvantage to a secured loan is that you need to keep up your repayments or you could risk losing your home
Alternatives to secured and unsecured loans
Loans aren’t the only borrowing option available to you. If you’re in need of money, consider one of the following:
Secured loans are available for much larger amounts than personal loans, which generally only go up to about £25,000
- 0% money transfer credit card: If you are only looking to borrow a few thousand pounds or less, this could be a better option. It lets you borrow funds interest free for a couple of years and move them into your current account. There’s a small fee, levied as a percentage of the amount you borrow
- Remortgaging: For large sums, if you have a mortgage it may be worth considering remortgaging to free up some cash. Mortgage rates are generally lower than secured loan rates. Downsides include higher fees, and the fact you could end up paying the interest on the whole amount owed for a multi-year mortgage term
- Guarantor loans: A type of secured loan, guarantor loans see friend or family member undertake to repay your loan if you default. These are available to borrowers with quite poor credit scores, but they come with fairly high rates – and the risk that you’ll upset your guarantor if you stop making repayments
Find the best deal on loans
Applying for a loan can feel like a guessing game – it’s hard to know whether you’ll be accepted, and what deal you’ll be offered. The interest rates and terms on both secured and unsecured loans vary widely, so it is vital to shop around for the best deal.
You can do this quickly and easily by using MoneySuperMarket to compare hundreds of different loans from a wide range of lenders. We use what’s known as a soft search on your credit history, so your credit score won’t be affected. When you’re pre-approved for a loan, you know that if you apply, you’ll definitely be accepted and you’ll definitely get the deal you see. The loan amount, duration and interest rate are all confirmed.
Moneysupermarket is a credit broker – this means we’ll show you products offered by lenders. We never take a fee from customers for this broking service. Instead we are usually paid a fee by the lenders – though the size of that payment doesn’t affect how we show products to customers.