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Secured versus Unsecured Loans

Secured versus unsecured loans

There are two primary ways in which to borrow money when it comes to loans -- you can take out secured or unsecured finance. Although these two types of loan have some significant differences, they do work in the same way on a basic level. With either a secured or an unsecured loan you borrow money from a lender and commit to pay it back to them on a regular basis (usually monthly) until the term of the loan is finished. At this point you will have repaid the sum of money you originally borrowed plus interest.

Factors to consider with secured and unsecured loans

One of the first things to consider before you apply for a loan is whether you will actually qualify for a secured loan. Secured loans are given to people who own something of high financial value (i.e. their home or other tangible asset) which they are prepared to use as collateral to back their borrowing. So, if you are not a home owner or have no suitable assets then you will not be approved for a secured loan. On the other hand unsecured loans can be taken out by just about anyone.

The primary differences between secured and unsecured loans can be seen in the interest rates that are charged. In general terms secured loans are cheaper than unsecured simply because they have the collateral behind them that makes them secured. So, if you use your home to secure a loan and then default on repayments then your lender can take action to recover the money you owe from your home. This means that you are a relatively low risk to a lender so they offer cheaper rates.

The rates of interest that you'll be given with a loan will be represented by a figure known as the APR (Annual Percentage Rate). APRs are varied in the lending sector -- obviously the lower the rate you can get here the better. Do be aware, however, that lenders do not give the same interest rate to everybody who applies for a loan. The rate you get may well depend on your financial circumstances and some people will pay higher/lower interest rates than others for what is otherwise exactly the same loan.

Another significant difference between these types of loan is the amount of money that can be borrowed. In general terms it is easier to raise larger sums of money with secured loans than it is with unsecured offerings. Again this is usually based on the fact that the collateral used to guarantee a secured loan could be used to help repay it so lenders are more comfortable giving loans for larger sums. But, remember that you do not HAVE to take out a secured loan if you are a home owner. If you simply want to take out a quick loan of more modest proportions then an unsecured product may be more suitable.

You may also find that in some instances secured loans can be set up to last for longer than unsecured ones. This is sometimes simply due to spending limits. In general both secured and unsecured loans will start with at least a 12 month duration which can be set to a longer period according to your preferences. So, for example, if you want to repay a loan in two years then you would take out a 24 month agreement. As you may imagine, you'll find the repayments are lower, the longer the loan lasts but that more interest will generally be charged. Taking out a loan for a shorter term will give you higher monthly repayments but less to pay back overall.

Setting up a secured loan can take a little longer than setting up many unsecured ones. With a secured loan the lender will need proof of collateral before your application will be approved. With unsecured loans -- in most cases -- the lender will simply take some details from you and run a credit check. If that check is OK then you could have approval in a matter of hours/days.

Do read the small print on any loan before you make an application. It is important to know all the terms and conditions that relate to your borrowing and your responsibilities. One thing to look out for here is the early redemption penalty fee. This may be charged to your account if you try to pay back a loan -- whether secured or unsecured -- early. Obviously, it is not in the best interests of a lender to have you pay off your loan before it is due as this means that they have to charge you less so many lenders try to mitigate their losses this way. But, not all loans will come with an early redemption penalty so it can be avoided.

Things to avoid when taking out a loan

Every time that you make an application for a loan the application activity will show up on your credit record. If you make a lot of applications in a short time frame then this activity may be viewed negatively by many lenders. It can, in fact, have an adverse effect on the credit score that they compile for you when you need approval for a financial product. This could result in a company turning you down either now or in the future. One way to avoid this is to ask lenders for quotes before you make any kind of application. Getting quotes is fine -- it's a sign of good financial management. But, too many applications at once just doesn't look good.

It's also wise to think about how you will manage financially with the loan. Do draw up a budget and check that you can meet all your standard expenses, your loan repayments and that you will still have some money left over for emergencies. It's very easy to get into financial trouble when borrowing so be as sensible about it as you can, keep borrowing to a minimum and try not to borrow more than you can afford from a repayment perspective.