Understanding the variable rate on a secured loan

You have decided that you need to borrow money. Perhaps you are getting married, planning a once-in-a-lifetime holiday, need a new car, or need to undertake emergency house repairs. But now you need to find the loan that not only offers you the money that you need but also the most favourable repayment terms.

To ensure that you select the loan that best meets your needs and also offers the best value for money, Free Price Compare is here to help you. In this article, we will discuss the differences between secured and personal loans, fixed and variable rates of interest and help you to determine which is the most appropriate form of loan for your individual circumstances.

What is a secured loan?

A secured loan is also referred to as a homeowner’s loan, a second charge mortgage or a home equity loan. This is because they are usually only offered to homeowners, as the loan is secured against an asset of value and this asset is usually the borrower’s home.

A secured loan allows individuals to borrow larger sums of money than would typically be possible with a personal loan, over a longer repayment period and often with lower interest rates. The reason why lenders only tend to offer this type of loan to a homeowner is that they require a high-value asset to use as collateral against the loan, thus reducing the risk that they are taking in lending the required funds.

In some rare instances, a lender may consider accepting a high-value vehicle, jewellery or art as collateral instead. In the event that a borrower defaults on their payments on a secured loan, the lender can initiate court proceedings to take possession of their asset and sell it to claim back the money that they are owed.

What is a personal loan?

A personal loan is a loan without security. These loans are usually for smaller amounts of money and have shorter repayment periods. They usually attract a higher interest rate than secured loans, representing the increased risk that the lender is taking in not securing the loan against an asset.

Any individual aged over 18 with the means to repay it can apply for a personal loan in the UK.

How is the interest rate calculated on a loan?

There are two ways in which the interest that is payable on a loan will be calculated. These are fixed rate and variable rate.

Fixed rate: A fixed rate is where the interest is charged at a set proportion of the value of the loan and will not change for its duration. Often, a fixed rate will be higher than a variable rate on a loan of the same value. In spite of this, many people prefer a fixed rate as knowing that the interest will not change over time provides greater certainty and budgetary control for borrowers.

Variable rate: A variable loan rate is usually calculated in line with the current market rate, which can increase or decrease in line with inflation [1]. This type of loan rate offers less certainty for borrowers. This is because whilst decreases in the market rate can result in them benefiting from cheaper loan repayments, should it increase, so too will their costs of borrowing.

A variable rate loan that looks cheaper at the outset may end up being more expensive than its equivalent fixed rate loan should interest rates rise. Always remember to consider the possibility of interest rate rises when opting for a variable rate loan.

Why are secured loan rates lower than personal loan rates?

Secured loan rates are usually lower than personal loan rates because they reflect the reduced risk taken by the lender in loaning the money that the borrower needs. Because a secured loan gives the lender the legal right to repossess the borrower’s asset of in the event of a default, this means that they are able to offer more attractive interest rates.

Secured loans also tend to be offered for a longer repayment period than a personal loan, with some repayment periods lasting up to 30 years. For this reason, even low interest rates can add up and provide a significant financial benefit to the lender by the end of the term.

When you perform a secured loan comparison, therefore, it is always worth considering whether taking out higher payments for a shorter term will offer better value for money than lower payments over a longer term.

How can I make sure that I get the best personal loan rates?

To secure a low interest personal loan, you can use the Free Price Compare personal loan calculator to compare personal loans from a variety of lenders across the whole of the market.

You should compare not only the monthly repayments and the interest rates of the loans on offer but also the total repayment cost. This ensures that you secure the best-value personal loan for your individual circumstances.

When conducting a personal loan comparison, try tweaking the repayment period of the loan to determine whether a slightly shorter repayment period could offer you better value for money. In doing so though, always remember that the repayments must be made in accordance with the agreed terms and conditions. Missing payments could affect your credit score, your ability to take out credit in the future and could even result in a lender taking court action against you.

It is therefore more important that you select a loan that is affordable month on month rather than the cheapest overall. You should consider the current and future affordability of the loan and consider how you would make the necessary repayments if your circumstances were to change. Ensure that you allow yourself an affordability buffer, particularly if you select a variable rate loan wherein the payments could increase without notice if the market rate increases.

If you have any concerns about your ability to repay a loan or need support in setting a manageable budget, you should discuss these concerns with a financial professional prior to taking out a loan. Free and impartial advice is available from Citizen’s Advice [2] and if the reason for your loan is debt consolidation, you should first discuss your circumstances with a debt charity such as StepChange [3] who may be able to offer alternative solutions for clearing your debt.

How do lenders determine the interest rates that they apply to a loan?

There are a number of factors that lenders will consider when determining how much they will charge for a loan. They will take into account your credit score, income and history of repayments. They will also consider the current economic climate when setting their interest rates.

A lender makes a risk-based decision as to whether or not to lend money to any particular individual. Where they agree to lend funds, the interest rate that they offer often reflects the level of risk they believe that individual poses to them.

A homeowner with a regular income and a good credit score will always achieve more favourable interest rates on a loan than a tenant with a fluctuating income or a poor credit score. People with multiple other debts such as loans and credit cards with other lenders will usually attract a higher interest rate, if they are approved at all.

Lenders will also consider the term of the loan, with shorter terms typically attracting lower interest rates as they will be repaid more quickly, again lowering the risk incurred by the lender.

Can I get a personal loan with bad credit?

It is possible to get a personal loan if you have a poor credit score. However, you will be limited as to which companies will lend to you and many will only offer small amounts, with high monthly repayments or high interest rates, both of which reflect the risk that you pose to them.

The Free Price Compare personal loan calculator will perform a soft search to identify the lenders and loans that will be available to you without impacting your credit score. In this way, you will be able to make an educated decision about whether to proceed with applying for a personal loan.

Is it better to choose a secured loan for the lower rates, or a personal loan for the lower risk?

Unless the reason that you need a loan is to make home improvements that will considerably add to the value of your home, it is usually better to take out a personal loan which represents a lower risk to you and your future.

Although the monthly repayments will probably be higher, the loan will more likely be repaid over a shorter period and at a lower total cost. This is why it is important to consider not only the monthly cost of repaying a loan but also the total cost of repaying it. Always look for the best value deal that you can afford.

What are the alternatives to taking out a loan?

1. Save

If you are considering taking out a loan to fund a discretionary (non-essential) purchase, the easiest alternative is simply not to do so, and to forfeit that purchase. By taking stock and identifying ways of reducing your monthly outgoings, or increasing your income, you can put more money into savings. In this way, should a similar opportunity arise in the future, you will be able to fund it from your own savings pot.

2. Credit card

If you really need to purchase an item or fund an event and there is no option not to do so, then you could consider using a credit card. Many credit cards are available with an initial 0% interest rate. This means that if you are able to pay them off in full before the end of this period, you will only repay the same amount that you initially borrowed.

Failure to do this, however, could cost you dearly, with interest rates often being considerably higher than the equivalent loan would be. Alternatively, you may be able to transfer the balance at the end of the 0% period to a different 0% credit card and pay that one off in full before the end of the 0% period.

3. Borrow from friends or family

Borrowing money from a friend or family member is another option that may be worthy of consideration, depending on your particular circumstances and the reason why you need the money. To safeguard your relationship with the lender, you should ensure that you have a legal loan agreement [4] written and signed by both parties. You should both agree to the terms and conditions of the loan, including how, how much and when you will pay them back.

In conclusion

The terms and conditions that are set on a loan are determined as a way to reduce the risk taken by the lender. Usually the more favourable that they are for the lender, the less favourable they will be for the borrower.

In order to ascertain which loan represents the best value for you, you should perform a secured loan comparison and a personal loan comparison. By selecting an appropriate amount and repayment period and then considering not only the cost of the monthly payments and the type of interest rate that applies, you will be able to identify the loan that offers the most favourable deal for you and also the total amount repayable.

Always remember that a variable rate loan will track the market rate, so where this is fluctuating rapidly, there is a high possibility that the loan will end up costing you more than the value quoted at the outset. If there is any chance that should the interest rate rise you could find yourself unable to afford the monthly repayments, always choose a fixed rate instead to safeguard yourself against defaulting.

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References

• [1] www.forbes.com
• [2] www.citizensadvice.org.uk
• [3] www.stepchange.org
• [4] www.netlawman.co.uk