A secured loan is a loan secured on a borrower’s major asset which is normally his or her property. The security refers to the lender holding a lien or ‘charge’ against the property in the event that the borrower fails to keep up with the monthly repayments.
An unsecured loan is borrowing where there is no security offered against the loan. With unsecured loans, the lender takes on more risk, which means you generally pay higher interest rates.
The decision as to whether you opt for a secured or unsecured loan is based on your goals and your credit history. Generally, interest rates on a secured loan are lower for all borrowers. Creditors feel much better loaning money when they have a fallback should a borrower become unable to repay the loan. Offering security to the lender allows you to borrow greater amounts as well. This is why mortgages (which are also secured lending) and secured loans offer much more available credit than credit cards or personal loans.
With the lower interest rates obtained through secured loans, your monthly payments are usually less than you would pay should the lending be unsecured. This obviously gives greater flexibility with your budgeting. Of course, overall you could well pay out more in interest repayments if you are borrowing money over a long period of time, even if the interest rate is low.
The biggest disadvantage, of course, with securing a loan against a property, is that your home will be at risk if you fail to meet your loan obligations. So you need to ensure that you would be able to comfortably afford your loan repayments before you agree to a secured loan.
Are you a ‘risky’ borrower?
When considering unsecured lending, the first thing you need to be aware of is that lenders take on greater risk when lending money that is unsecured. There is more of an implied trust with unsecured loans. Your credit history is extremely important when borrowers consider your application for an unsecured loan. A strong credit history communicates that you are less of a credit risk and that you are likely to meet your loan commitments. In this case, lenders award higher loans with better rates and terms to less ‘risky’ borrowers.
Of course, the biggest benefit with unsecured loans is that your property is not at risk. Another benefit is that payment terms are usually not as long with unsecured loans, so while you may be paying more in interest, as it is being paid over a shorter period of time, you could still save money on interest repayments.
Unsecured loans can also be arranged a lot quicker – you can apply one day and have the money in your bank account within a few days, if everything is on order.
Conventional mortgages usually have a 20 - 25 year loan repayment plans while secured loans are around ten to fifteen years. Terms for personal loans usually are much shorter -anything from a year up to ten years. The biggest disadvantage is that your monthly payments are higher because of the shorter repayment period. Interest rates are higher also, regardless of credit, without property used for security.
What you should remember
Borrowers must weigh up the advantages and disadvantages of secured versus unsecured loans when choosing the right solution. Key points to consider:
- Secured loans always require a property lien due to the significant amount of lending involved but you can borrow a greater amount over a longer period of time
- And secured lending can take a few weeks to arrange as your property will need to be valued by an independent surveyor to ensure that there is enough security within it should you default on your loan repayments
- Unsecured lending on the other hand is quicker to arrange, and there is less financial risk should you default on your repayments, but you will be borrowing a smaller amount over a shorter period of time, typically paying a higher interest rate
- By establishing a good credit history, you will give yourself a greater opportunity to be approved for a reasonable, unsecured loan. If banks find you to be a risky prospect, you may have no other option but to look for a secured loan.
