Secured loans vs unsecured loans

What are secured loans?

A secured loan is a form of borrowing that requires you to use an asset as security. This will often be your home, but it could be any other valuable asset, including your car, jewellery or antiques.

How secured loans work

A secured loan lets you borrow a lump sum of cash from a lender. You then repay this sum with interest over a set term. Repayments are typically monthly and loan terms can stretch to 35 years.

Because secured lending requires an asset as collateral, it’s less risky for the bank. This means you can borrow larger sums of £25,000 and above. Loan interest rates can be more competitive too.

However, if you can’t meet your repayments, you could lose the asset used as security.

Advantages of secured loans

• Lower interest rates: Because secured loans are less risky for lenders, interest rates can be more competitive.
• Higher borrowing limits: You can usually borrow more with a secured loan than other forms of borrowing.
• Longer repayment terms: You can repay secured loans such as mortgages over terms as long as 35 years, reducing your monthly repayments.
• Can be easier to get: Because the collateral reduces the lender’s risk, it can be easier to qualify for secured loans, even with poor credit.

Disadvantages of secured loans

• You could pay more in interest: Longer loan terms mean you’ll pay more interest overall.
• You’ll need a valuable asset to qualify: You won’t be able to get a secured loan unless you have a valuable asset to use as security.
• Your asset is at risk: If you default on your loan repayments, you risk losing your asset, which could be your home.
• Interest rates may be variable: Some secured loans have variable interest rates. That means your monthly repayments could increase in the future, so be sure to check.
• Early repayment charges may apply: If you repay your loan early, you might incur a fee.

Common uses of secured loans

Popular reasons for using secured loans include:

• Buying a property: The most common type of secured loan is a mortgage.
• Pawnbroking: You could borrow money in exchange for a valuable item that you own, such as jewellery or a musical instrument. There are nearly half a million pawnbroker loans a year worth £500 on average, according to the Financial Conduct Authority.
• Home improvements: Secured loans can help pay for extensive home renovations, such as an extension.
• Consolidating debt: You could use a secured loan to consolidate existing debts into one monthly, manageable repayment.

What are unsecured loans?

Unsecured personal loans also enable you to borrow a lump sum of cash from a lender. But, unlike secured lending, you won’t need to put up anything as security for the money.

How unsecured loans work

If you’re accepted for an unsecured loan, the money will be transferred to your bank account and you’ll start making repayments. Like secured loans, these repayments are usually monthly and include interest.

Because there’s no collateral involved, it’s better for the borrower. But the loan agreement is riskier for the lender. This means lenders will be more wary about who they lend to. You’ll usually need to undergo a stricter risk assessment before you can qualify.

Interest rates on unsecured loans are generally higher compared with secured loans. Terms are shorter too. They can be high-cost short-term (HCST) credit – sometimes called payday loans. Loans tend to be from as little as £50 and may last just a few weeks or months. Unsecured bank loans typically last one to seven years and can be up to £25,000.

Advantages of unsecured loans

• Less risky for the borrower: Because you don’t have to use an asset as collateral, there’s no risk of losing it.
• Fixed repayments: Unsecured loans mostly have fixed interest rates, so your monthly repayments won’t change.
• Less interest paid: Shorter repayment terms mean you’ll pay less interest in the long run.
• Quicker application process: It can be quicker to apply for an unsecured loan compared with a secured one.

Disadvantages of unsecured loans

• Harder to qualify for: You might need a good credit rating to qualify for an unsecured loan and secure the best rates.
• Lower borrowing limits: You won’t be able to borrow more than around £25,000.
• Higher interest rates: Because they’re not backed by collateral, unsecured loan interest rates tend to be higher than those on secured loans.
• Impact on credit score: If you don’t make your loan repayments on time, you risk damaging your credit score. This could make it harder to qualify for credit in the future.

Typical uses of unsecured loans

Unsecured lending is commonly used for:

• Home improvements and repairs: Unsecured loans can help pay for essential repairs at home – a new roof – or renovations such as a new bathroom. You might also use an unsecured loan to fund new home appliances.
• Car expenses: Funds from a loan could cover the cost of car repairs or help pay for a second-hand or brand-new car.
• Debt consolidation: You can use an unsecured loan to consolidate debts into one monthly repayment.
• Payday loans: Short-term loans are unsecured and let you borrow from £50 to £1,500 for between a few weeks and 12 months.

Comparing secured vs unsecured loans

When considering whether to apply for a secured loan or unsecured loan, you’ll need to think about the following:

Interest rates comparison

Interest rates on secured loans tend to be lower than rates for unsecured lending. What’s more, you’ll need an excellent credit history to qualify for the best rates on an unsecured loan.

When you see loans advertised with a representative APR, this is the rate that must be offered to at least 51% of successful applicants. The remaining 49% may be given a different rate, usually several times higher.

Impact on credit score

Secured and unsecured loans can have a similar credit score impact. Your payment history for both types of loan will be reported to the three main credit reference agencies – Experian, Equifax and TransUnion.

If you make your repayments on time, your credit score should start to increase.

But if you’re late or miss repayments, this can hurt your credit score. If you miss several repayments, you will default on the loan. This can have an even bigger impact on your credit score.

Risk to borrowers

Secured loans are riskier for the borrower. If you fail to meet your monthly repayments, you could lose the asset you used as security. This could mean losing the roof over your head.

Unsecured loans are less risky for the borrower as there is no collateral involved. But defaulting on your loan can still lead to serious consequences. The lender could start debt collection proceedings or take court action against you.

How to choose between secured and unsecured loans

Before deciding which type of lending is right for you, it’s worth doing the following:

Assessing your financial situation

Secured loans enable you to borrow a larger sum of money compared with unsecured loans. But just because you can borrow more doesn’t mean you should.

Borrowing more than you can afford to repay can increase your default risk.

Before deciding whether a secured or unsecured loan is best, go through your bank statements to remind yourself of how much income you have each month and how much you spend on household bills, debts and other expenses.

This should help you work out how much you can realistically afford to borrow and whether your loan repayments will be manageable.

Note that if you already have a high debt-to-income ratio, you probably shouldn’t be borrowing more.

Considering your long-term financial goals

Think carefully about your reasons for taking out a loan and your long-term financial goals.

If you’re planning to use the loan to buy assets, such as property, or to pay for renovations that could add value to your home, a secured loan could be a good option. Loan interest rates are generally lower, and you can choose longer repayment terms.

But an unsecured loan could be better if you want to borrow funds to consolidate debt or buy a new washing machine.

Understanding your risk tolerance

If you’re thinking about applying for a secured loan, you need to ensure you fully understand the risks involved.

If you’re uncomfortable about using an asset as security, an unsecured loan could be the more appropriate choice.

Here’s a summary of the differences:

*High-Cost Short Term Credit

FAQ: Secured vs unsecured loans

Can I convert a secured loan into an unsecured loan?

It’s unlikely you’ll be able to convert a secured loan into an unsecured loan. Even if you could take out an unsecured loan to repay your secured loan, there are several reasons why it might not be worthwhile.

For a start, the outstanding balance on your secured loan would need to be small enough to be covered by an unsecured loan. It’s also likely you would pay a higher interest rate and, as unsecured loans have shorter terms, your monthly repayments could increase. Also, be aware you may have to pay an early repayment charge on your secured loan.

What happens if I default on a secured loan?

If you miss your repayments for several months, you will be in default and the lender could ultimately repossess the asset used as security. This could be your home.

Repossession is the last resort, so if you’re worried you might miss repayments, speak to your lender immediately. It should work with you to come up with a more manageable repayment plan.

In situations where you think your lender has provided you with an unaffordable loan, perhaps because it didn’t carry out the necessary affordability checks, you complain to the Financial Ombudsman Service (FOS). But this can be a lengthy process.

Are secured or unsecured loans better for consolidating debt?

Whether secured or unsecured lending is better for debt consolidation will depend on several factors. These include your credit score, how much you need to borrow, and how long you need to repay it.

Unsecured debt consolidation loans are the lower-risk option. But interest rates tend to be higher, particularly if you have poor credit.

Secured loans are riskier but may be more suitable if you have a lot of debt to consolidate (more than £25,000). Interest rates tend to be lower and terms are longer. You’re also more likely to be accepted if you have poor credit but a valuable asset.

Conclusion: Secured vs unsecured lending

Secured and unsecured loans both have their pros and cons, so you’ll need to weigh up carefully what works best for you. This will depend on factors including:

1. Whether you have an asset to use as security
2. How much you want to borrow
3. How long you need to repay the loan
4. Your credit history.

But remember, if you secure debts against an asset, such as your home, this could be repossessed if you don’t keep up with your repayments.