Secured vs. unsecured loans: What’s the difference?
Different loans are issued with different purposes in mind – home improvements, vehicle purchases, debt consolidation and so on. Depending on your requirements, both secured and unsecured loans could be equally viable options.
But which of the two is better, in terms of both convenience and affordability? Is one type of loan always the preferable choice where available, or is it more circumstantial?
What is an unsecured loan?
An unsecured loan is a loan issued on the basis of trust and merit. Lenders base their decisions on the current financial position and general track record of each applicant, in accordance with their own unique qualification criteria.
In order to qualify for an unsecured loan, you will usually need to have an excellent credit score, formal proof of income and no ‘blemishes’ on your financial background. This is because unsecured loans are not backed by any specific form of collateral, i.e. assets of value, thereby making them a higher-risk transaction on the part of the lender.
How do personal loans work?
Personal loan applications are assessed on the basis of the lender’s pre-set qualification criteria. For example, you may need a certain credit score to qualify, and you may need to earn a certain amount of money per month to be considered eligible.
A personal loan application will usually be processed fairly quickly – sometimes even the very same day. Most unsecured loans are limited to a maximum value of around £10,000 or £15,000, but can be used for any legal purpose with almost no restrictions.
The balance of the loan is then repaid over a series of monthly payments, typically over the course of no longer than five years, you can work out the cost of these monthly payments by using a secured loan calculator.
What is a secured loan?
Secured loans differ in that the money provided by the bank is secured against one or more of the applicant’s owned assets. A typical example of a secured loan is a mortgage, where the security (or collateral) for the loan is the applicant’s home.
With secured loans, the lender has the legal right to take ownership of the assets and sell them to recoup their losses if the applicant defaults on their repayment obligations. But as secured lending is considered safer for the lender, loans can be issued at more competitive rates of interest and in significantly higher amounts.
How do secured loans work?
Secured loans are issued primarily on the basis of the value of the assets used to secure the loan. In order to qualify for a secured loan, you will need to provide your lender with evidence of the value of your assets, and proof that you are their legal owner.
Additional financial status checks and credit checks are less important with secured loans, as the assets serve as an insurance policy for the lender. There are no limitations on how much can be borrowed, repayment can take place over several years or decades, and borrowing costs can be lower than those of a comparable unsecured loan.
But as your assets may be repossessed by your lender in the event of non-repayment, secured loans should not be taken out without careful forethought and financial planning.