Unsecured loans versus secured loans
What's the difference between a secured and an unsecured loans? Let's take a look.
There are two types of personal loan: secured and unsecured.
When you take out a loan, the type you have depends on how the lender is legally able to recover any money you can’t repay:
Also known as guaranteed loans. Here, there is some form of security against the loan, like a property in the case of a mortgage, or a car in the case of many types of vehicle finance.
These are forms of credit where there is no asset that a lender can claim as security. These include personal loans, credit cards and even the overdraft on your current account.
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The key differences between secured and unsecured loan
How much you can borrow
Perhaps the main reason that lenders sometimes need an asset to be used as security is because the sums involved are so high.
When it comes to mortgages, for example, banks and building societies routinely lend hundreds of thousands of pounds.
They wouldn’t want to risk this much money without a bricks-and-mortar property to lay claim to in case something went wrong.
The amount lenders will offer via an unsecured personal loan, however, is usually a lot less.
We’re talking around £5,000 or £10,000 and no more than £25,000. In the same way, credit card and overdraft limits tend to be well under £10,000.
Your chances of being offered credit
If you apply for any form of unsecured credit, lenders will check your credit record first.
That will help them work out whether to accept your application – and also the rate of interest to charge you.
A history of missed repayments, for example, is likely to count against you. With secured credit, on the other hand, you might be able to obtain finance even if your credit record is patchy.
That’s because the lender will have a guarantee in the form of the secured asset.
This tends to happen more with car finance rather than with mortgages, as banks strictly assess mortgage applications.
Read more: How to improve your credit rating
What happens if you default on your repayments?
If you can’t carry on making the repayments on an unsecured personal loan or credit card, the lender won’t be able to claim any of your assets to settle your debt.
So your house or your car are safe. But that doesn’t mean there are no consequences.
If you don’t pay off any unsecured borrowing then you could receive penalty charges. It might lead to a black mark on your credit record too, making it difficult to borrow in the future.
Lenders can also call in debt-collection agencies to get back what they are owed.
You might even face the risk of being forced into bankruptcy. Things are a bit more clear cut if you miss repayments on a secured loan.
On a mortgage, for example, you are at risk of having your home repossessed, And on a secured car loan, your vehicle could be taken back in order to clear any outstanding debts.
Again, though, things like missed repayments will go down on your credit file.
Read more: A guide to cancelling your car finance
Car finance: secured or unsecured?
If you want to borrow money to fund a car purchase, you can choose between secured and unsecured loans.
But you can take out an unsecured personal loan to cover the cost of your purchase.Then, if you miss repayments, your lender has no right to claim your car.
Bear in mind that, if credit is secured against the vehicle, you may be allowed to borrow more – or at a lower rate – than on an unsecured personal loan.