When you’re in need of a loan, whether to buy a car, pay off debt, or fund a significant purchase, you’ll likely encounter two main types of loan: secured and unsecured. Understanding the differences between these two can help you make an informed decision and choose the best option for your financial situation. Let's break it down and compare these from a customer’s perspective.
What is a secured loan?
A second-charge mortgage, often referred to as a secured loan, is backed by collateral—something valuable that you own, like a house, car, or savings account. This collateral serves as security for the lender, which means that if you default on the loan, the lender has the right to take the asset to recover the money. Common examples of secured loans include mortgages and car loans, homeowner loans and Home Equity Lines of Credit (HELOCs).
Key features of secured loans:
- Lower interest rates: because the lender is exposed to less risk (they can take the collateral if you don’t repay), secured loans usually come with lower interest rates.
- Larger loan amounts: secured loans often allow you to borrow larger sums than unsecured loans, as the collateral the borrower puts up reduces the lender’s risk.
- Credit flexibility: if your credit score isn’t perfect, a secured loan might be easier to obtain because the collateral provides extra assurance to the lender.
- Longer repayment periods: with secured loans like mortgages and HELOCs, you can access longer repayment periods than with the typical unsecured loan. Selina’s HELOC <hyperlink> for instance, offers repayment terms that range between five and 30 years.
- Could end up costing more in the long run: While the longer repayment periods that secured loans usually offer can be attractive in terms of lower monthly payments, the disadvantage is that you may end up paying more interest over time.
What is an unsecured loan?
An unsecured loan, on the other hand, doesn’t require any collateral. The lender relies entirely on your creditworthiness and financial history to decide whether or not to lend you the money. If you fall behind or default on your payments, the lender can’t automatically take your assets, but they can pursue legal action to recover the debt. Examples of unsecured loans include personal loans, credit cards, car loans, and student loans.
Key features of unsecured loans:
- Higher interest rates: since unsecured loans carry more risk for the lender, they usually come with higher interest rates.
- Smaller loan amounts: Lenders will be more restrictive about the amount they’re willing to lend on an unsecured loan because there’s no collateral tied to the loan.
- Strict credit requirements: to qualify for an unsecured loan, you usually need a good to excellent credit score and credit history. This is also because the lender doesn’t have additional collateral to rely on.
- Your assets aren’t at stake. Since unsecured loans aren’t tied to collateral, you aren’t at any immediate risk of losing your home if you default on the loan.
Secured or unsecured? Which loan type is right for you?
Of course, your decision to take a secured or unsecured loan will depend on your financial situation. Key factors to consider are the amount you need to borrow and how comfortable you are with risk.
Consider choosing a secured loan if:
- You have valuable assets (like a home) that you’re willing and able to use as collateral.
- You're taking out a large amount of debt that you need to repay over a long period of time, as with a mortgage.
- You don't have a good enough credit history to qualify for an unsecured loan with low interest rates.
- You’re confident in your ability to repay the loan, as the risk of losing your collateral is a real concern.
Consider choosing an unsecured loan if:
- You don’t want to risk losing your assets if you can’t repay the loan.
- You have a strong credit history and can qualify for the terms required, despite the lack of collateral.
- You only need a smaller loan amount or want a quicker approval process, as unsecured loans often have a simpler application process.
Final takeaways:
Taking out a loan is an important decision and many factors should be considered when making the choice.
If you’re confident that you can keep up with repayments, choosing a secured loan can be a financially savvy way to secure a large amount of money, and/or more affordable interest rates. But if you think that making timely payments might be a struggle, this might not be the best type of loan for you.
On the other hand, an unsecured loan might be the best choice if you don’t want to secure your loan against your property. Interest rates may be slightly higher, but if you have good credit and do your research, rates can still be competitive.
Always remember to evaluate your personal financial situation carefully and consider the risks before taking on a loan. If the choice feels overwhelming, we recommend using a broker.
To learn more about how Selina can help improve your personal finances, visit our site.
