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Whether you're looking for a loan to help you cover the costs of moving house or want to consolidate your debt, you may be wondering what sort of loan is best for you. There are two primary forms of loan: secured and unsecured. Knowing how these loans vary can ensure you find the right one for you and your financial needs.
So, what is the difference between secured and unsecured loans?
Let's take a look at these loans in more detail.
A secured loan requires you to offer up an asset as collateral. They are sometimes called 'homeowner loans' as the debt is often linked to a property — for example, a mortgage. However, mortgages are not the only forms of secured loans. You may also take out this type of loan to purchase a car or stocks.
With a secured loan, the lender will hold the asset (such as the property deed) until you've paid the money back in full. If you can't repay, the lender can take your home and sell it to recoup their losses. By having your property or other assets as collateral if you default on your payments, lenders can offer lower interest rates and APR.
Unlike secured loans, unsecured loans have no collateral. This means that lenders take more of a risk — there's no asset to recover if you fail to repay. As such, unsecured loans have higher interest rates, meaning lenders will have to assess your financial situation before offering you the money.
Student loans, credit cards and personal loans are all examples of unsecured loans.
Pros and cons of secured loans
Secured loans are great if you have an asset to put up as collateral. They have lower interest rates, making repayments more affordable in the long run. They also allow you to borrow large amounts of money so you can make major purchases that will greatly impact your life. As well as having higher borrowing rates, secured loans have longer repayment terms, meaning you can spread the cost over the years.
Another benefit of a secured loan is that you may be able to take one out if you have a less-than-perfect credit score. Because your property acts as security, you have a chance of being approved for a secured loan even if you don't have the best credit history.
Having said that, if you want the best interest rates on your secured loan, you do still need a good credit score. To be eligible for this type of loan, you also need to be a homeowner.
Although you have the option to spread repayments over a long period of time, doing so may mean you pay more in the long run. Secured loans usually require a minimum repayment period of five years.
Another downside to a secured loan is the risk of asset loss. If you default on three or more payments, your lender may take action and repossess your home.
Pros and cons of unsecured loans
One big benefit of an unsecured loan is the fact that you don't need to be a homeowner. You can take out a credit card or personal loan even if you rent, making unsecured loans accessible to a wide range of people. They are an excellent choice if you need to borrow a smaller amount of money. Secured loans usually require you to borrow at least £10,000. However, with an unsecured loan, you can sometimes borrow up to £25,000.
Another advantage of unsecured loans is their flexibility. You can usually decide how long you'd like your repayment period to be.
An unsecured lender offers you money based on your financial resources. This is great news if you are in a strong position and have a good credit score.
But what about unsecured loans for poor credit? A downside is that most lenders will reject your unsecured loan application if you don't have a high credit score. Moreover, because there's no asset to hold for security, lenders see unsecured loans as a higher risk. Therefore, they charge higher interest rates which can lead to you spending more overall.
As you can see, an unsecured loan is a useful way of borrowing smaller amounts of money. However, in order to qualify, most lenders check your credit history and assess whether the loan is affordable for you. They need to be confident that you can make your monthly repayments.
If you're interested in applying for an unsecured loan, you need to build up your credit rating to prove a lender can rely on you to pay the money back. You can do this by having a regular income, ensuring you always pay your rent and bills on time and checking that all your personal details are correct and up to date.
Credit checks may seem daunting, but, fortunately, there is another option. At Abound, we offer affordable unsecured loans and look at the whole picture rather than just your credit score. We assess your affordability by looking at your bank transaction data (using open banking tools). You can borrow between £1,000 and £7,500 over three years at Representative 18.8% APR (variable).
As with any form of borrowing, an unsecured loan does come with some risks. However, providing you are confident you can afford to pay it back, an unsecured personal loan can be a helpful way of getting your finances in order. Just make sure you never borrow more than you can are confident you can repay in the future.
If you'd like to learn more or wish to apply for an affordable personal loan, apply for an Abound loan today.
