Which type of loan is best for you and your financial goals?
Secured and unsecured lending are two primary types of credit available to most of us – but what are the key differences? How do these two forms of borrowing help you make informed decisions about your financing needs?
We explore the five big differences between secured lending vs unsecured lending:
Do you need assets?
Secured lending involves using a valuable asset as collateral to secure a loan. This asset can be a property, a vehicle, or another valuable item – often it is secured against the item you are purchasing – which is handy. If you default on the loan, the lender gets the assets to recover their funds.
Common types of secured lending in the UK include mortgages and car finance used to purchase property, secured by the property or vehicle itself and loan-to-value (LTV) loans where the amount borrowed is a percentage of the value of any asset used as collateral.
Unsecured lending does not require any collateral to secure the loan. Instead, the lender assesses your creditworthiness and financial stability and decides whether they are good for it.
This includes personal loans used for things like home improvements, debt consolidation, or a holiday, credit cards that offer revolving lines of credit that allow borrowers to make purchases, and overdrafts that let you essentially borrow from your bank.
How much do you need to borrow?
Secured loans allow you to borrow larger amounts because secured loan lenders are typically willing to offer larger loan amounts when there is collateral to secure the debt. This is particularly true of loans secured against the item purchased – so a car of house – as the lender has the reassurance that the asset will more than cover the amount borrowed against it.
Unsecured loans are typically for lower amounts – credit cards and overdrafts etc. Often the loan agreement is made in advance and the unsecured loan lender asks for detailed financial information so they can agree amounts.
What are the Rates and When do you Need to Pay it Back?
Secured lending attracts lower interest rates due to the reduced risk for the lender. For example, a mortgage on your home which will have a lower rate usually pegged to the Bank of England Base Rate in some way or fixed for a portion of the term – two, three or five years. Secured loans have longer repayment terms making it easier to manage monthly payments over a planned repayment period.
Unsecured loans generally have higher interest rates than secured loans due to the increased risk for the lender. They are often shorter terms too – as the lender wants to see the return of the funds quite quickly.
What about the Risk?
Any secured loan always carries the risk of repossession. If you use an asset to secure a loan – including the one you are purchasing with the loan – and you default on that secured loan, the lender can repossess the collateral. This could mean losing your car or even your home if you do not keep up your regular payments.
The risk with unsecured loans is mainly with the unsecured loan lender themselves. They stand to lose the amount of the loan if you default. This makes them inclined to lend lower amounts to more people, spreading the risk. If you take out an unsecured loan you are agreeing to make the repayments on the understanding that if you don’t, and the lender is forced to go to the law to get their money back, you will not only find it harder to borrow from them again, but due to the use of the credit scoring system, you will find it harder to get any kind of credit in the future. This could impact on your ability to get mobile phones or even book holidays and travel.
How Flexible do you Need to Be?
Secured loans are far less flexible. They almost always have more stringent requirements and less flexibility. Once you are locked into an arrangement you can only make changes to that by agreement with the lender. Secured loans often have minimum terms and and you could incur charges just for paying a secured loan off more quickly.
Unsecured loans are far more flexible and often allow for rolling credit – where a number of purchases can be made under the same terms and can get paid off with a single monthly payment. The best example of this is the credit card. As long as you make the minimum payment each month and stay within the limit the lender has set (based on your financial circumstances) you can continue to make purchases whenever you like.
In conclusion – Secured vs Unsecured Lending
Secured and unsecured loans have some key differences. The best type of lending for you will depend on your individual circumstances and financial goals. You should always consider the following factors when making your decision:
- Your financial situation: Assess your credit score, income, and expenses to determine your eligibility for different types of loans.
- The purpose of the loan: Consider the reason for the loan and whether you need a large loan amount or flexible repayment terms.
- Your risk tolerance: If you are comfortable with the risk of losing collateral, a secured loan may be a good option. If you prefer to avoid this risk, an unsecured loan may be more suitable.
Get in touch today to hear more about MHG Capital’s secure lending opportunities. Learn more about how we work and how we can get you earning higher yields.