Finding the best loan is not just about getting the cheapest rate – you also need to decide whether a secured or unsecured is best for you. Here’s what you need to know.
THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE OR ANY OTHER DEBT SECURED ON IT.
If you need to make a big purchase, loans can be an affordable and straightforward way to borrow money.
They broadly fall into two categories – secured loans, where you offer an asset as a guarantee that the lender can sell to get their money back if you can’t repay it, and unsecured loans, where you don’t.
A secured loan is a cash loan that is tied to an asset you own. If you are unable to pay back your loan the lender can repossess the asset to get their money back.
Most lenders use property as their security, but some will let you use other items like your car or other valuables.
Secured loans tend to be for larger sums or to buy specific items, like vehicles or property, and often have lower interest rates than unsecured loans. They set a maximum loan-to-value (LTV) that you can borrow.
The loan-to-value ratio is the size of a loan compared to the value of the asset you’re using as security.
For example, if you owned a property outright worth £200,000 and the maximum LTV was 75%, the most you could borrow would be £150,000.
While this sets an upper limit, how much you can borrow is still based on what you can afford and your credit record. You’re likely to get a better deal borrowing a lower LTV.
You can borrow larger sums than with unsecured loans
You can still borrow if you have a poor credit history
Longer loan terms are available
They put your property at risk
There are limits to the proportion of the asset’s value you can borrow
Rates can be variable as well as fixed
Homeowner: These loans are secured against your property and are often for larger sums over £25,000, although you can borrow as little as £7,500. They can last for anywhere from 3 to 25 years.
Logbook: These loans are secured against your vehicle and the money you borrow can be used for any purpose. You may be able to borrow 50% or more of your vehicle’s value. They can usually be taken out for up to five years. Logbook loans tend to have relatively high interest rates.
Vehicle finance: These loans are secured against the vehicle you buy using a finance agreement. Once you have made the final payment you will own the vehicle. The loan could last for one to five years.
Bridging: These loans are usually secured against your property and are normally large loans to bridge the gap before other finance is available – for example, if you need to buy a new home before your current one is sold. They tend to have higher interest rates than other types of loan but are designed to be taken out over short periods, which could be as short as a day although 12 months is common. You’ll need an exit strategy for how you intend to pay off the loan when you take one out.
Debt consolidation: Secured loans can often be used for debt consolidation. The loan is secured against your property, or sometimes other assets, to pay off existing debts with the aim of reducing your monthly repayments.
An unsecured loan is a cash loan that doesn’t require you to provide anything as security; you just borrow money from the lender as a lump sum and pay it back over an agreed amount of time. Interest rates are usually fixed.
You could borrow up to £25,000 with an unsecured loan, sometimes more, and they can last between one and 10 years.
How much an unsecured loan will cost depends on how risky a borrower the lender considers you to be – this is known as risk-based pricing. Some of the things lenders look at include:
How much you want to borrow
How long you want to borrow for
Your credit record
How much other credit you have applied for recently
No risk to your property
More flexible than a secured loan
Quicker to apply
You need a good credit history for the best rates
They can be more expensive than secured loans
Loan amounts tend to be smaller
Personal: These loans let you borrow a cash lump sum and pay the money back over an agreed amount of time.
Guarantor: These loans allow you to borrow money with the help of a friend or family member who guarantees to pay back the loan if you can’t.
Peer to peer: These loans allow you to borrow money from other people online in exchange for a return on their money from the interest you pay.
Debt consolidation: Unsecured loans can often be used to pay off your existing debts to make them easier to manage and cheaper to pay back.
Both types of loan share some of the same risks, including:
You could take on borrowing you can’t afford, although the lender must check that you can afford to pay the loan back when you apply
You credit record could be damaged if you miss payments
You may have to pay fees if you are late paying or miss a payment
You could be taken to court if you default on the loan, which is normally considered to be the case once you’ve missed payments for three to six months
Secured loans also put your belongings at risk, because the lender can repossess whatever you have chosen to list as security for the loan if you can’t pay it back.
If there are two identical loans but one is secured and the other unsecured, conventional wisdom suggests picking the unsecured loan.
Typically, you should only choose a secured loan over an unsecured loan if:
It is much cheaper than the unsecured alternative
You need to borrow over a longer term – more than 10 years
You need to borrow a large amount – more than £25,000
This is because the secured loan is tied to your property or another asset so puts it at risk if something were to go wrong and you couldn’t pay the loan back.
Unsecured loans - or personal loans - do not have collateral requirements, but with secured loans you would have to put up an asset like your home or car as a guarantee.
No, you will need to apply for two separate loans if you decide to do this.
Unsecured loans tend to be quicker because the lender doesn’t need to check the value of your security when you apply.
Yes, you can get a joint loan for both. If you apply for a secured loan with someone else they will need to also own the property you use as security.
New secured loan deals are recorded on your credit report, just like unsecured loans.
As long as you repay on time, having either sort of loan should improve your credit score. Conversely, if you're late with payments or default on the loan it will lower your credit score.
Salman is our personal finance editor with over 10 years’ experience as a journalist. He has previously written for Finder and regularly provides his expert view on financial and consumer spending issues for local and national press.