Anytime you borrow money from a Bank, a Loan Company or even an individual, you’re taking out a loan. The lender may allow you to borrow the money with only your promise to pay it back. Or, the lender may require that you use an asset as security for the loan. These alternative options show the difference between secured and unsecured loans. The detail of this difference is important. If you are considering taking out a loan and you have a sum in mind, you need to understand how the detail might affect you, so read on….
A secured loan (sometimes referred to as a homeowner loan) is one where the debt is linked to the borrower’s property. They are therefore only available to people who own or are buying their own homes and can be used to borrow anything from £5,000 upwards. In other words, the money you borrow is backed by an asset (like a house in the case of a mortgage, or a car with an auto loan). When you agree to the loan, you agree that the lender can repossess the asset if you don’t repay the loan, as the paperwork you signed, shows you agreed to do.
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. For instance: if the Lender wants your house as security for the loan, the amount you will be able to borrow will depend upon 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.
You need to consider carefully whether you can make the regular payments on your loan because; even though lenders repossess property for defaulted secured loans, you could still end up owing money on the loan if you default. When lenders repossess property, they sell it and use the proceeds to pay off the loan. If the property doesn’t sell for enough money to cover the loan, you will be responsible for paying the difference.
This type of loan is like ‘the promise’ mentioned in the first paragraph, but that promise will be made into a contract on paper, which you will have to sign. An unsecured personal loan is not tied to any of your assets and the lender can’t automatically seize your property as payment for the loan. Personal loans and student loans are examples of unsecured loans because these are not tied to any asset that the lender can take if you default on your loan payments.
Unsecured personal loans are available to would-be borrowers who have at least a fair credit score – you do not have to be a homeowner to apply. They can be used to borrow anything from say £1,000 to £25,000. However, they are generally at their cheapest for borrowing of between £7,500 and £15,000.
Secured loans are available for much larger amounts than personal loans, which generally only go up to about £25,000.
If you have a less-than-perfect credit history, you may find that you have no choice but to opt for a secured rather than a personal loan. As your property acts as security they can be easier to qualify for.
The repayment periods on secured loans can also be longer, while the fixed monthly payments should make it easy to manage the repayment plan. It is essential to keep up repayments on a secured loan to avoid the risk of losing your home or any other asset your loan was secured by.
Because the loan is secured on your property or other form of asset, if you end up being unable to make your repayments, you risk losing whatever asset you took the loan against.
Some secured loans have early repayment penalties, so if you were in a position to pay off the loan early you may have to pay additional fees or charges.
Unsecured personal loans are widely available to a larger proportion of people, especially now that many couples and families cannot afford to buy a home of their own, even when they have a reasonable income.
They offer the flexibility to choose the length of repayment terms, with most borrowers making fixed repayments for between one and five years.
Some loans offer the option of a payment holiday of say two or three months at the start of the agreement, to allow the Borrower time to organize their income and outgoings.
The best loan rates are generally for borrowers looking to make repayments over three and five years, meaning you will often pay a higher interest rate to borrow over a shorter term.
The interest charges on larger or smaller amounts can prove expensive.
Top deals are only open to those with high credit scores.
Whilst missing payments will not risk your home, this could still drive you deeply into debt, as the interest rates on an unsecured loan may be quite high
As with anything, read the small print, as some unsecured personal loans do have fees and charges such as early repayment penalties.
And Finally: The interest rates and terms on both secured and unsecured loans vary widely, so it is vital to shop around for the best deal. Study the terms and conditions for fees and charges such as early repayment penalties which could increase your borrowing.