Secured & unsecured loans: What are they?
When choosing a loan, the first step is to figure out what sort of loan you actually want. Broadly, there are two main types of loans, secured and unsecured loans. Should you want to borrow a large sum of money, such as for a mortgage, you will most likely look for a secured loan. This is where the creditor will have a high value asset of yours, such as your house, as collateral should you be unable to pay the loan back. If you are borrowing a lower sum of money you will most likely want an unsecured loan, which is essentially the same but you do not have to put any assets up as collateral. This guide will take you through all you need to know so that you can compare loans, including the alternatives that are available for you.
In This Guide:
- Secured loans
- Advantages of a secured loan
- Disadvantages of a secured loan
- Unsecured loans
- Advantages of an unsecured loan
- Disadvantages of an unsecured loan
A secured loan is a type of borrowing where an asset of yours is ‘secured’ agains the credit. This essentially means that you put your house, or maybe even your car, as collateral which the creditor can take should you not pay off your debt, or even miss payments. Taking out a secured loan will mean the creditor can offer you more favourable terms, as they have an insurance policy. Typically, people who take out secured loans are either looking for a large sum of money (for instance if you were taking out a mortgage) or if you have a bad credit score.
Advantages of a secured loan
- Normally this process will be faster than an unsecured loan, as there are less requirements for approval.
- Allows you to borrow with more favourable terms, meaning a lower interest, over a longer period of time.
- From a lenders point of view , because they have the asset as collateral it lowers their risk.
- Secured loans such as mortgages can be used to finance other assets, you can remortgage your house in order to help you pay other debts.
Disadvantages of a secured loan
- Should you fail to pay back your loan you will lose the asset that you put up as collateral.
- Because you are paying it back over a longer period of time, you will end up paying more interest overall, even if the lower interest means a lower monthly payment.
Often referred to as a ‘personal loan’, when you hear the phrase ‘unsecured loan’ just think of the opposite of a secured loan. This means that you do not need to ‘secure’ anything against the debt. Should you be unable to pay the loan back, they cannot take your house or car, but they can go through legal and court channels. Typically, unsecured loans are given to people who have a good credit score or are not borrowing a large amount of money.
Advantages of an unsecured loan
- There is less risk for you as the borrower, because you are not securing any assets against the debt. This means that they are less risky than secured loans.
- Because you do not have to secure any high value assets, you are not disadvantaged should you not own a house or a car.
Disadvantages of an unsecured loan
- You will not be able to borrow as much as money as you could through a secured loan.
- As there is no collateral, there will be higher interest rates than a secured loan.
- It will be harder to take out an unsecured loan should you have a bad credit score.
Debt Consolidation Loan
Instead of taking out a personal loan in order to navigate your debt you can ask for what is called a ‘debt consolidation loan’. This will essentially put all of your debt together and you will instead pay it back in one, more manageable, payment every month.
Secured Credit Cards
If you have minimal credit history, this could be the option for you. A secured credit card is insured on a savings account which is used as the collateral. This will allow you to use the credit card to purchase something expensive, or use in an emergency should you not automatically have the funds available.