Which is more advisable: a secured or unsecured loan?

May 30th, 2022
Which is more advisable: a secured or unsecured loan?

If you need access to some extra funds, taking out a loan may be the ideal solution. Yet with so many different financial products out there, it can be hard to know which option is likely to be the best choice for your circumstances. Two popular kinds of loans are secured and unsecured loans, so having a clear understanding of the pros and cons of these products can go a long way in helping you to confidently make a decision. Read on to discover some of the considerations in deciding whether to opt for a secured or unsecured loan.

The loans business is booming here in the UK, with the total amount of money borrowed by consumers amounting to almost £28 billion [1]. A lot of this debt is held on credit cards, but the high interest rates involved make this a very expensive way to access extra funds.

A Look At Unsecured Loans

The most popular type of loan here in the UK, the average person has approximately £9000 in unsecured debt [1]. The main difference between secured and unsecured loans is that for an unsecured loan, you won’t be required to put up any form of collateral (something of financial value that might be resold by the lender in the event that you default on your loan agreement). However, without asking for any form of collateral as a guarantee, the cost of taking out an unsecured loan can often work out as greater than the cost of a secured loan. This greater cost can take the form of higher interest rates, meaning, of course, that you will end up paying back more over the duration of the loan period. Furthermore, the amounts available to borrow are typically smaller than for a secured loan, usually in the margin of £1000 to £25,000.

Nevertheless, there are a number of key advantages to taking out an unsecured loan. This kind of loan offers greater flexibility when it comes to the repayment period, with the most unsecured loans being repaid over terms of one to five years. This is itself a far shorter period than that associated with secured loans, which typically have a repayment period of a minimum of five years. It’s often easier to repay your unsecured loan early, too, without the level of difficulty or penalties that usually accompanies the early repayment of secured loans.

Without putting up any form of collateral as a guarantee, you won’t face the prospect of having it taken by the lender should you become unable to make the agreed repayments. Knowing that your home (the most common form of collateral) won’t be put at risk can certainly be a great source of peace of mind, but it’s important to note that defaulting on an unsecured loan will still have financial implications. Your credit report and score will be negatively affected, making it harder to be accepted for finance in the future.

If you decide that an unsecured loan is the right choice for you, then there are ways to get a better deal. Having a great credit report can help to reduce the interest rates you are offered, as well as substantially increasing your chances of being accepted for the loan in the first place.

A Look At Secured Loans

Secured loans, meanwhile, require that you put up some form of collateral in order to be granted the funds. This typically takes the form of the house you own, although other items with financial value that compares to the loan amount (valuable jewellery or vehicles, for example) will be considered by lenders. The value of the collateral you offer acts as a guarantee to the lender, thereby reducing the risk of making the loan, and reducing the cost (in terms of interest rates) to you. This also means that even if your application for an unsecured loan is turned down, or you have a poor credit rating, you could still find that you can access funds through a secured loan. The downside, of course, is that your home or other assets could be seized if you fall behind with your loan repayments.

There are other advantages to taking out a secured loan, such as the ability to borrow far larger sums of money. With a secured loan, you may be able to borrow up to a six-figure amount, making this kind of loan a more practical choice if you are planning to use the money for an extension or other significant home improvements.

There are a few other important points to note when looking at secured loans. For example, should you put your home up as collateral and you move house during the loan repayment period, you will usually be expected to repay the balance of the loan at this point. And if you decide to repay your secured loan early, you may find that it is more expensive, with a penalty charge of around one to three months interest (depending on how much money you still owe) likely to be levied.

What About Car Finance?

When it’s time to buy a new car (or even just a new-to-you car), the sums involved can make taking out a car finance deal look very appealing. After all, both main dealerships and second-hand car dealers now routinely offer finance for their vehicles, some with little to no deposit required upfront. In fact, selling these car loans can be an important source of revenue for these dealerships, so it’s little wonder that they are heavily featured in their advertising campaigns.

When it comes to a choice between a secured or unsecured car loan, the main difference to bear in mind is that for a secured car loan, the car you buy will be used as collateral. Whilst this kind of loan gives you access to lower interest rates, as with other types of secured loan, you risk losing the car in the event that you can no longer afford the repayments. Bear in mind that these interest rates may be variable, which could drive up the monthly repayment amount. Furthermore, you may find that you do not fully own the vehicle until the total loan amount is paid off.

In the case of car finance, an unsecured loan can be a more straightforward option. There will likely be a higher rate of interest on the sum borrowed, but you will own the car outright from the date of purchase. However, there will be financial repercussions should you fall behind in your repayments, ranging from an adverse effect on your credit report and score, to being taken to court by the lender in an attempt to regain their money.

An Unsecured Or Secured Loan: Making Your Choice

So, how do you know which kind of loan would be the best choice for you? There are a few key criteria to consider when making your decision. First of all, look at the rates of interest associated with the different loans in which you’re interested. The lower the interest rates, the better value the loan, and, if you have a good credit report and score, you may well discover that you are eligible for unsecured loan rates comparable to those of a secured loan.

Next, think about how much you would be happy to pay each month, and see if your loan will allow the flexibility to accommodate your ideal repayment schedule. Look at the total period of the repayments and balance out the benefits in affordability that could come from taking a longer repayment period, against the additional cost of the interest that you’d pay.

The amount that you want to borrow will almost certainly play a part in your decision, too. If you are looking to renovate your home, then a secured loan will be more likely to cover the sums involved. Meanwhile, if you have a smaller expense to cover, such as a career development course, then an unsecured loan could be a better choice.

Possible Alternatives To Secured and Unsecured Loans

There are other types of loan available, which, depending on your circumstance, may represent a good choice. These include remortgages, which tend to offer lower interest rates than secured loans, and guarantor loans, in which a friend or relative provides the financial guarantee for your borrowing. This kind of loan can however come with higher rates of interest, plus the risk that your friend or family member will be forced to pay, should you be unable to make the agreed loan repayments.

For small amounts, a 0% money transfer card can be another option. This allows you to borrow up to a few thousand pounds interest-free over a short period and charges a small fee which is calculated against the sum you borrow.

So called Pay Day loans, whilst being advertised as a fast and convenient way to access funds for a short term period, should, however, always be avoided. This kind of loan charges cripplingly high levels of interest, meaning that even with a short repayment schedule, consumers will likely find themselves repaying far more than the amount borrowed.

Get Expert Advice

Taking on debt should never be done lightly. In the UK, thousands of people are currently reaching out to Citizens Advice Bureau for help with their debts [2], whilst one person in the UK and Northern Ireland is declared bankrupt every five minutes. If you are concerned about the amount of debt that you have accrued, then there are organisations that can offer practical advice and assistance. The Money Advice Service offers free, impartial help for anyone in the UK who is concerned about debt (https://www.moneyhelper.org.uk/en/money-troubles/dealing-with-debt/use-our-debt-advice-locator?source=mas# )

Meanwhile, if you want to be sure that you can comfortably afford loan repayments before you commit to an agreement, then using a budget calculation tool can be a great idea. Tools, such as the free calculator offered by Citizens Advice (https://www.citizensadvice.org.uk/debt-and-money/budgeting/budgeting/work-out-your-budget/ ) can make it easy to understand exactly how much you could afford to spend on monthly loan repayments, as well as providing other useful insights into ways that you might reduce your household expenses.

This can be useful if you are planning any life changes in the near future that might impact your ability to repay your loan, such as starting a family or returning to education.

Interest Rates

Always bear in mind that interest rates can rise. If you opt for a loan with a variable rate, this will increase the monthly payment and overall cost of your loan. Remember that if you have opted for a secured loan, your home could end up at risk if you fall behind with your agreed repayments, so it is absolutely essential that you ensure you can afford the payments, whatever happens with interest rates.

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