What is an unsecured loan?
Unsecured loans are also sometimes known as personal loans.
These loans allow you to borrow money without giving your lender security (such as your home or your car) against the loan. This means it is much more difficult for a lender of an unsecured loan to repossess your home or your car if you don't keep up with your loan repayments.
These days, many borrowers can get a pretty hefty loan if they want. The maximum amount you can borrow for a personal loan is normally £25,000.
Personal loans also tend to offer fixed interest rates. That means you'll know exactly how much you have to repay each month regardless of any changes to interest rates in the wider market.
An alternative to unsecured loans: 0% balance transfer cards
If you want to take out an unsecured loan to pay off debts you have run up on store card, credit cards or an overdraft, instead of taking out a loan, you could opt to transfer it all onto a 0% balance transfer card (subject to a fee). This means won't pay any interest on your debt for a set period, often a year. However, if you haven't paid off your debt in full after this set period ends, you will have to move it again to avoid paying a high interest rate.
What is a secured loan?
With a secured loan, the lender secures its loan against an asset you own. This means that, if you fail to pay back a secured loan, the lender can take possession of that asset in order to get its money back. Usually the asset is a home.
You are often able to borrow more money as a secured loan than you would with an unsecured loan; sometimes over a longer period too.
Secured loans may be offered on a variable rate of interest. This means the amount of interest you have to pay may vary over the course of the loan term, and your monthly payments could go up or down.
Before we move on, let's say it again: secured loans put your home at risk. Think very carefully before taking out a secured loan.
An alternative to secured loans: remortgaging
If you are coming up to the end of your current mortgage deal, consider remortgaging for a larger amount instead of taking out a secured loan. The interest rates on a mortgage are normally cheaper than on a secured loan. If your current mortgage deal has some time to run, you may be able to get a further advance from your current mortgage lender. Again, the interest rates you will pay will probably be cheaper than on a secured loan.
In what circumstances are secured loans a good idea?
In most circumstances, a secured loan is not a good idea -- although it will be suitable for a minority of borrowers. Usually, however, you are much better off with an unsecured loan or a 0% balance transfer card.
However, if you want to borrow over £25,000 you may find it difficult to do so unless you offer to secure the loan against one of your assets. Similarly, to make the payments affordable, you may also want to spread your loan over a very long period of time.
In this situation, you may be better suited to a secured loan. But before you venture down this route, please consider remortgaging instead. The interest rates on a mortgage deal are usually cheaper than on a secured loan.
Unfortunately, this still isn't the answer for everyone. The problem with remortgaging is that you will often have to pay early repayment charges if you took out you current mortgage deal recently and are tied into that deal for a set period.
Even so, you still have another option. You could potentially opt for a ‘further advance' (a.k.a. a second mortgage) from your current mortgage lender. Again, this type of loan is likely to be at a more competitive interest rate than a secured loan although it won't necessarily be at the same rate as your original mortgage. But if you can't get a further advance and it would be very expensive to remortgage, then you may want to look at getting a secured loan.
There is another circumstance where a secured loan might be appropriate: if you have got a residential mortgage at a competitive rate, but your credit rating has deteriorated since you first took it out. Why is it appropriate in this circumstance? Because if you remortgaged now or took out a further advance, there's a chance you could end up paying a higher interest rate than you would on a secured loan.
If you think this situation applies to you, it still may well be worth getting professional advice from The Motley Fool Mortgage Service before going down this route. It won't cost you anything, and it could save you thousands…
FACT OR FICTION: A secured loan is safer than an unsecured loan
FICTION: Some borrowers may assume that secured loans are safer than unsecured loans. But this is a mistake. In this situation, ‘secured' means safer for the lender, but more risky for you.
The reason why secured loans are actually more risky than unsecured loans is because you are putting up your home as collateral against the loan.
In other words, you are effectively offering the lender compensation in the form of ownership of one of your assets if you fail to pay back the loan. So if you do not meet your mortgage payments, your property will be repossessed.
Most lenders will only agree to lend you large sums of money (over £25,000) if the loan is secured against an asset.
FACT OR FICTION: If I take out an unsecured loan, I am not putting my home at risk
FICTION: If you are a homeowner, and you default on an unsecured loan, your creditor may be able to secure a charging order against your property – even though you didn't ever, at any point, offer up your property as collateral against the loan.
A charging order means that when your property is sold, your debt will have to be paid before you can receive any money from the sale.
What's more, if a charging order is granted, your creditor may then apply to the court for an Order for Sale. If this is granted, then the procedure works just as if you had taken out a secured loan and were having your home repossessed -- the house will be sold, the creditor gets his money and you're homeless. Alternatively, the judge may decide to give you enough time to sell the property yourself.
However, because your creditor has to jump through all these legal hoops, it is much more difficult for them to repossess your home if you default on an unsecured loan, instead of a secured loan. However it is still possible and you should bear this in mind when taking out an unsecured loan.
FACT OR FICTION: The longer you take to pay off a loan, the more you will pay in interest
FACT: The less time you take to pay off your loan, the better. Think very carefully when deciding how long the period of the loan should be. If you spread your payments out over 5 years instead of 3, the monthly payments will be smaller but you will pay more in interest over those 5 years, so it will be more expensive overall.
Make sure the payments are affordable and try to go for a loan that you can pay off early, without incurring any charges.
Checklist: Things to watch out for if you're taking out a loan
Typical APRs: To quote a ‘typical APR' the lender only has to offer that loan to 66% of its customers. If you have a poor credit rating, you may not be offered this rate.
Tiered interest rates: Lenders often offer better rates to customers who borrow over a certain amount. If you are looking to borrow just less than £5,000, you could actually be better off borrowing just over £5,000, in order to secure a better interest rate. But check your figures using our loans calculator before you make any decisions.
Repayment holidays: You might think this is a good feature, as it allows you to take a short holiday from your repayments. But actually, you are still incurring interest on your debt during this time, which means it will take you longer to pay it off eventually.
Early repayment charges: Some loan providers will charge you a penalty if you find you can afford to pay off your loan early. Paying off a loan early is a good idea because it will save you money in interest, so look for a loan that you can pay off early, without incurring any charges.
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