If you’re interested in borrowing money, then you may have done a little research and looked around some of the big-name lenders that we often see advertised on TV, on the internet and even in newspapers. However, there are likely two terms that have confused you; secured and unsecured loans.
These two terms are very simple to understand, and in this article, we’ll be doing some explanations as well as giving examples to help you grasp the concept.
When you’re borrowing money, the lender needs to have some form of guarantee. A secured loan means that the money you’re borrowing is attached to a piece of collateral. In other words, something valuable with a monetary value that is similar to your loan amount. For example, if you’re taking out a loan to pay for an emergency expense, then a secured loan could be against possession like your car or even your home (homeowner loan). Secured homeowner loans are like mortgages and are secured against your home or a rental property.
If you fail to pay back the loan in the allotted time, then the loan company has the right to repossess the possession that you put up as collateral. Car loans, mortgages and second charge mortgages are the most common forms of collateral used in secured loans, and it’s a very common way for lenders to ensure that they’ll get their money back, one way or another.
Secured loans often come with much better interest rates, and they’re a common option for people to rebuild their credit rating especially if they’ve been through a period of poor financial management. When speaking to lenders, a secured loan will likely be the most common form of loan they offer you unless you’ve proven that you’re responsible with your money.
Unsecured loans, on the other hand, don’t require a form of collateral. This is generally only accepted if the company offering them trusts you. For instance, you need a relatively good credit rating to take out an unsecured loan, but there are also times when you can take out an unsecured loan with a relatively poor credit rating but with a much higher interest rate.
Unsecured loans are typically seen with credit cards, student loans and personal loans. They’re typically higher in interest unless it’s for a very specific reason or you’ve got an excellent credit rating and a history with whatever financial company you’re dealing with.
Unsecured loans are harder to apply for without a solid credit history, but they offer a bit more flexibility and you won’t be at risk of losing a piece of collateral if you do fail to honour the repayment terms.
In most cases, a secured loan will have a much better interest rate because the lender knows that whether you pay back the loan in time or not, they’re going to get their money back. For an unsecured loan, all the lender can do is continue to pile up interest and eventually get their money back over a longer period of time. This usually results in lower borrowing limits but is much more convenient for you.