If you find yourself in the position of needing to take out a loan, you will have a choice between a secured or unsecured loan. In this article we explain the difference between these two options, outline the advantages and disadvantages of each and talk you through the application process for each one.
What is a secured loan and how does it work?
A secured loan is a loan backed by an asset, which is normally your home, but could also be another valuable item such as a car or piece of jewellery. It means that, if you fail to make the repayments on the loan, the lender has the right to repossess the item that has been put up for collateral. This has the result of making the loan a safer bet for the lender, which normally means the terms are better, but a riskier option for borrowers.
Secured loans are also known as second charge mortgages or home equity or homeowner loans. You can choose to get a further advance from your current mortgage lender, which will typically be at a different rate from your first charge mortgage. Alternatively, you may opt to get the secured loan from another lender, if you can get it for a better rate. Another option is to remortgage and release some of the equity in your property to create a single, bigger loan.
What is an unsecured loan and how does it work?
As the name suggests, an unsecured loan doesn't require any security in the form of collateral. The borrower simply agrees to pay back the money owed and faces extra charges and penalties that can accrue if payments are late or missed. The other risk with this type of borrowing is that missed payments will appear on your credit record and could impair your credit rating. If you persistently fail to repay, the debt is likely to be passed on to a debt recovery agency and you could be taken to court.
An unsecured loan is typically more expensive than its secured counterpart as the lender has less of a guarantee of getting the money back. In addition, there isn't usually the scope to borrow as much money as with a secured loan. However, as a borrower, there is less at stake if you don't keep up repayments, the application process is quicker and there is more flexibility in terms of how long you have to repay the loan.
What are the advantages of a secured loan?
- The rates are typically lower, as they pose less risk to the lender
- You can borrow larger amounts, with most loans over £10,000, although they start at around £3,000
- It can be used for more substantial spending, such as house renovations, a car purchase, a wedding or to consolidate other debts
What are the disadvantages of a secured loan?
- The item you secure the debt against - most often your home - will be at risk if you don't keep up repayments
- There may be an early repayment charge that restricts you from paying off the debt earlier
- The application process is robust and more time consuming than for an unsecured loan. It is also necessary to conduct more in-depth research to ensure it's the best option for you
What are the advantages of an unsecured loan?
- Unsecured loans are more widely available than secured loans and the application process is relatively straightforward
- There is less risk of losing your home if you don't keep up repayments, although it could impact on your credit record and your capacity for future borrowing
- You can generally pay off the debt as quickly as you like, sometimes without incurring a financial penalty
- The interest rate tends to be fixed, so it is easy to budget for the repayments
What are the disadvantages of an unsecured loan?
- The interest rate is typically higher than for a secured loan and you may not be able to borrow as much
- You may be less likely to be eligible for an unsecured loan if you have poor credit
- There is still some risk involved if you don't keep up repayments
How to apply for an unsecured loan?
There are a wide range of unsecured loans available, so the first step is considering how much you would like to borrow and what period of time you can pay it off over. Then, compare the various deals available, looking for the most attractive interest rates and terms. When you have worked out which one you are interested in, check the eligibility criteria to see if you are likely to be accepted before making your application. It's a good idea to check your credit file to help with this process to see if there are any black marks that could jeopardise you being accepted.
To apply for an unsecured loan you will typically need:
- Personal details, including name, date of birth and address details for the past three years
- Bank details
- Information on monthly expenditure and existing financial commitments
- Details of your employer, if you are working
If your application is successful, most lenders transfer the money to your account within a few days, with some releasing it within 24 hours. If, however, you are turned down, be wary of applying for a loan with another lender until you have an understanding of why you have been rejected. Each application appears on your credit file and a string of failed attempts can damage your credit rating.
How to apply for a secured loan?
The process of securing a loan against your property can take up to six weeks to complete, although this varies from lender to lender. This is because checks need to be made on the property, including how much it's worth, who has legal ownership of it and whether it is leasehold or freehold. There are also additional checks on the prospective borrower, including their identity, creditworthiness and income. There is also a 7-day cooling-off period, which gives the person applying for the loan time to properly consider whether it is the right option for them.
There are several steps to follow when applying for a secured loan:
- Consider how much you need to borrow and the affordability of the loan. It can be tempting to take on a bigger debt than you need if the rates are low but, with your home at risk if you don't keep up with the repayments, it's not a good idea to borrow more than you can comfortably afford. You also need to take into consideration what would happen if your financial situation changed, for example, if you lost your job
- Work out the valuation of your property and the balance on your existing mortgage. This will give you an idea of how much you will be able to borrow. Your existing mortgage lender might be able to provide a valuation based on the information it already has or you may need to employ the services of a surveyor.
- Compare the loans available, looking at the rates available and the terms of the loan, including whether there is an early repayment charge if you want to settle the debt more quickly
When you are ready to start your application, make sure you have documents to hand that provide proof of identity, your address for the past three years, proof of income and expenditure, as well as the relevant documents on the property. Although the process can be quite arduous, once you have been approved, the money should be released and available to use relatively quickly.
Can I get a secured loan with poor credit?
If you have a less-the-perfect credit history, you are more likely to be accepted for a secured loan than an unsecured loan, as the lender has greater certainty that they will get the money back. Indeed, secured loans are often used as a tool to consolidate other debt when people are in financial difficulty. That said, you will still have to pass an eligibility test to make sure the loan is affordable and that you are likely to be able to repay it. The criteria used varies from lender to lender, with some willing to accept applicants with a history of missed payments, CCJs and bankruptcy and others only willing to lend to those with a higher credit rating.
A number of lenders specifically target sub-prime customers, although the rates you are offered are likely to be higher than if you had an unblemished credit history. It is also worth scrutinising your finances to ensure it is realistic that you will be able to repay the loan and to make sure you don't repeat bad repayment practices that you may have had in the past, as this could have devastating consequences when your home is at stake.
Will having a secured loan affect remortgaging?
Many people who require extra borrowing may simply choose to remortgage as this enables them to release equity from their home rather than taking out a secured loan. Some homeowners, however, may be restricted from doing so because they are in the middle of a fixed-rate or tracker mortgage deal and so may face an early repayment penalty.
When they reach the end of the introductory period of their deal and face moving on to the lender’s standard variable rate, they will probably then be looking to remortgage. So, does having a secured loan affect this? In short, yes, it is likely to add some complexity to the process.
The borrower has two choices:
- Remortgage and increase the borrowing to be able to pay off the existing secured loan. This has the advantage of simplifying your finances as you will only have to make one monthly repayment rather than two. There is also the additional advantage of the interest rate on the remortgage potentially being lower than on the secured loan. Remember however that as the term is likely to be longer, you will be paying the debt off over more years and so you could end up paying more in interest over the lifetime of the loan.
- Keep the secured loan separate from your mortgage. This could be an attractive option for those who have a particularly good rate on their loan or who have a short amount of time left before it is paid off. The danger is that some lenders won't agree to remortgage your property if there is a secured loan in place and, if they do, the cost of the secured loan will be part of the affordability stress testing they will apply to assess eligibility.
Should I get a secured or unsecured loan?
The choice between a secured and unsecured loan will largely be decided by the amount you want to borrow, your financial circumstances and your willingness to potentially lose your home if you are unable to repay the loan. A secured loan can be a useful way of getting a grip on your finances if you have existing debts or need to access a larger lump sum, perhaps for work on your property that will ultimately increase its value. Meanwhile, an unsecured loan is perhaps a better option if you only need to borrow a relatively small amount and would prefer to repay it over a shorter timeframe. Both options require serious consideration, in the same way as taking on any debt does.
If you are struggling with debt then you may find the following articles useful:
- The impact of debt on your mental health and how to get help
- The 5 simple steps to clear credit card debt
- What is the best way to consolidate my debt
- Remortgaging to consolidate debt, is it a good idea?
Alternatively, there are many websites and charities that provide free debt and financial advice, some of which are listed below:
- National Debtline
- Citizens Advice
- The Money Advice Service
- The money charity