What is the difference between secured and unsecured loans?

Whether it be a loan for a new car or second charge borrowing for much-needed home improvements, those looking for some form of financing will likely come across secured and unsecured loans. Below we have explained the difference between these types of borrowing, and which form will be best suited for you.

A secured loan is a form of borrowing where an asset, usually the borrower’s home, is used as a form of collateral in case of missed payments. This means there is typically less risk for the lender as they have legal means to recoup their money if the borrower cannot repay their debt.

This is why many secured loans have lower rates than their unsecured counterparts. However, remember that loan rates are ultimately determined on a variety of unique factors, which includes amount of financing and your credit rating.

For the borrower, this does mean that they may be forced to sell their assets or have them repossessed if they cannot keep up with their payments. In addition to this, their credit score will be adversely affected.

Secured loans are often preferred by borrowers who require large sums of money. If you can use some of the equity in your home as collateral, lenders may feel more comfortable providing you with larger loan amounts

Likewise, these loans are often ideal for those with an impaired credit score. Since secured loans offer lower risk than an unsecured loan, lenders may be more inclined to offer some borrowers money knowing they can recoup their money in the case of default. Meanwhile, if the borrower keeps up with their planned payments then they can increase their credit score.

Secured loans include, but are not limited to:

• A mortgage
• Second charge lending (where the equity in your home is used as collateral)
• Equity release
• A commercial bridging loan

An unsecured loan is a form of borrowing in which the borrower’s valuables are not at risk. However, even though there is no collateral, defaulting on your payments still comes with consequences. Many lenders will apply late payment charges, which will ultimately increase the amount you owe. If left unattended for too long, these missed payments will dent your credit score and restrict your access to lending in the future.

Unsecured loans are similar to credit cards in that the financing is not secured against another asset. Therefore, those looking for a credit card should also consider using an unsecured loan before making their decision. While credit cards have a borrowing limit, unsecured loans provide their borrowers with a set amount and a monthly instalment plan. This can help some consumers stick to a budget and give them an idea of when their debt will be repaid. In addition to this, the average personal loan generally offers a lower rate than the average credit card.

Unsecured loans are also ideal for some who do not have some form of collateral to apply for a secured loan. For example, those renting a home might not have the required assets to get a secured loan and may opt for an unsecured loan.

Unsecured loans include, but are not limited to:

• The majority of personal loans (As long as it does not require any form of collateral)
• Unsecured business loans

See our guide on the differences between unsecured personal loans and business loans.

Instead of using a loan, there are other forms of borrowing which you may wish to use instead.

Credit cards can be an ideal option for borrowers looking for limited financing. As opposed to a personal loan, credit cards give their users flexibility with their payment structure, with users only obliged to make the minimum monthly payment. Still, it is preferable that credit card users pay off as much of their debt as possible to avoid unnecessary interest charges.

Additionally, those looking to transfer a small amount from their current account can look at using an overdraft. While this form of financing can be convenient to use, it typically includes greater interest rates than credit cards.

Those looking for a larger form of financing, and who hold a mortgage, can look at a remortgage as another form of financing. This is similar to a second charge loan, but applies to variable borrowers and those coming towards the end of their fixed-term deals. So, when remortgaging, access to the equity in their home is considered as part of their new mortgage agreement.

Those looking to use their home as a form of financing can read our guide on the best way to release cash from their home.