Are you currently thinking about making an application for credit, but are unsure as to whether or not you should apply for a secured or unsecured loan? In order to help you make the right decision, we have put together a guide on everything that you need to know about secured loans so you can decide if this will be suitable in your circumstances.
What is a secured loan?
To start off with let’s clarify exactly what we mean by a secured loan. This is a type of loan that has an asset, which represents the collateral for the loan. What this means is that if you end up missing a payment, or end up defaulting completely on the loan in question, the lender or bank is able to collect the collateral that you have put up. Generally speaking, this results in a lower overall interest rate for you, as the bank entails less risk in providing you with the loan because it has the option of being able to collect the collateral if you end up defaulting on payments at a later date. It can also be a good option if you are trying to build credit, providing that you go through a reputable lender.
Types of secured loans
There are a number of different types of secured loans that are available for you to choose from. These include:
- Secured credit cards. This is where a bank requires the applicant to make a deposit against the card’s stated limit, which then guarantees you the loan. This will usually be done for customers who are trying to improve a bad credit score that they have, or if they are trying to build upon their credit history
- Car loans: these are secured against the car itself as if you end up defaulting then the lender has the right to repossess the vehicle
- Mortgages: these are also secured, because the property you have been given a loan for is the collateral in this case here, meaning that it can be repossessed if you cannot make repayments for the mortgage
- Businesses: For companies, an individual can apply for business loans which are secured against their mortgage or car. This is a common thing done by high-risk entrepreneurs, but in some cases, it can provide some extra cash flow and liquidity to a business.
Benefits of secured loans
Getting a secured loan can be advantageous for a multitude of reasons, but these can depend on your own personal circumstances. For example:
- They can be a great option if you have found yourself in a situation where you have been declined an unsecured loan
- They can also help to build upon your credit score and history, providing that you use them correctly, ie. you make sure that you pay back the loan in full and on time. The long-term impact of having a good credit score is significant. It can help you to gain access to better interest rates with other kinds of loans you may decide to apply for at a later date, as well as increase the overall chance of you being accepted for an application for credit, as having a bad credit score can lessen your chances dramatically
- You will usually have a lower interest rate with a secured loan. This is because it is not as risky for a lender or bank to give you a secured loan as there is a high-value possession that is acting as collateral. An unsecured loan may have higher interest rates due to the fact there is more risk involved for them, so a higher interest rate reflects this
Disadvantages of secured loans
Of course, secured loans have some pitfalls too, and this is something to be aware of prior to deciding whether a secured loan is right for you.
- There is the risk of losing whatever you have put up as collateral (your car, home, or another high-value possession) if you fail to make your repayments for the loan. This can be obviously a huge concern and particularly risky if you think there is a reasonable chance you default in the future. You may find that it is better in this scenario to apply instead for an unsecured loan, such as a guarantor loan. With a guarantor loan, you need a second person to act as a guarantor in order to be able to receive the loan, and they also tend to allow you to borrow a higher amount than you usually would if you had poor credit. You also do not need to fear that your home will be repossessed if you can’t pay the loan back
- It can often be the case that secured loans have variable rates, which could be disadvantageous. This is in contrast to personal loans, which usually have fixed rates, whereas if you have a secured loan with a variable rate it means that you could end up in financial difficulties in the future if interest rates suddenly increase.
Alternatives to a secured loan
You may still want to apply for a loan but have now decided that perhaps you would like to look at other options than a secured loan. We take a look at the most popular types of unsecured loans available on the market:
- Guarantor loan: as previously mentioned, this type of loan allows you to borrow with the help of a family member or friend
- Personal loan: with these loans, you borrow a cash lump sum up front and then over an agreed amount of time pay the money back
- Debt consolidation loan: it is worth noting that not all debt consolidation loans are unsecured. But if they are, these loans can be used in order to help you pay off multiple existing debts that you have, which can make it easier for you to manage as well as less expensive to pay back