Secured versus unsecured loans

Which type of loan is best?

The answer to that is, neither of them is best every time. It depends on your circumstances, what you want the loan for, the interest rate charged, and a lot more.

Unsecured loans: definition

The difference between the two types is fairly easy to remember, because it’s in the names. A loan that is unsecured means that you’re not putting up anything as security for the lender. So if you stop repaying your loan without agreeing this with the lender (or "default" on your loan), nothing of yours is at risk. This type of loan is often called a personal loan. Typical examples are credit cards and overdrafts, as well as general purpose borrowing.

Why would you want an unsecured loan?

You might not want to put anything up as security for the loan; after all, the future is uncertain. Or you might not own anything suitable. In this case, going for an unsecured loan might be the best or the only route.

Pro:

  • This type of loan allows you to get hold of money in a short time - maybe even less than 24 hours.
  • Because you haven’t secured this type of loan, you won’t lose any security if you default on it.
  • If you have a good personal credit history, there’s a good chance you will be able to find this type of loan.

Con:

  • Interest rates on unsecured loans tend to be higher than on secured ones - so you pay more per pound to get access to the loan. That’s because the loan is a greater risk to the lender.
  • If you have a poor credit history, you’re unlikely to be accepted for an unsecured loan without paying a very high interest rate.
  • Particularly in the past, this sort of loan was so easily available that many people got into a big mess acquiring too many of them - more than they could repay when their income went down, often through redundancy.

Secured loans: definition

Again, the name provides the definition. With a "secured" loan, you put up something as security. If you default on the loan, that item may be at risk. The classic example of a secured loan is a mortgage. The security in this case will be your home. If you fall behind with your payments, you could end up losing that home in a repossession. Not a pleasant prospect. It doesn’t have to be a house, though; other things could act as security, such as a car. Or indeed anything that a lender is happy to accept as security - and that you are happy to risk.

Why would you want a secured loan?

Secured loans tend to be for higher amounts than unsecured loans. Again, the obvious example is a mortgage. Houses are so expensive compared to most people’s available cash, that many people could never buy one without the aid of a substantial loan. A typical mortgage could easily be for £200,000. Not surprisingly, lenders are not going to hand over that sort of money without something solid as security.

Pro:

  • Secured loans allow to buy things you might not be able to afford for a long time if you saved up your money. In fact, you might never be able to afford some things such as houses without a loan.
  • Interest rates tend to be lower than with unsecured loans.
  • Even if you have a poor credit rating, you might still qualify for a secured loan (although the interest rate might be higher).
  • The repayment period can be a long time - as long as 25 years. So each monthly repayment can be more affordable as a result.

Con:

  • If you default on the loan, you could lose the thing you’re buying. To take an extreme example, you could have been paying off your mortgage for ten years – but if you default on your repayments, you could lose that house.
  • You could be in debt for a long time while you pay off a secured loan.

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Updated on 9th December, 2009

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