Choosing a Secured or Unsecured Loan

By Michael Strauss

It's easy to be tempted into taking out a new loan, especially if your current financial situation isn't as good as it can be. Loan adverts promise a way out of money troubles, by reducing your monthly repayments and simplifying your whole financial life. This can indeed be true, but choosing the wrong kind of loan can make things considerably worse, not better.

How do you know which kind of loan to go for? There are many, many things to consider when choosing a loan, but the most basic choice is whether to apply for a secured or an unsecured loan, and it's essential to understand the difference.

Unsecured Loans

Unsecured Loans are probably the most common type, and are generally referred to as personal loans. These are the loans which are on offer from your bank, or from popular financial services outlets such as credit card companies, or even these days supermarkets.

These loans are usually for small to medium amounts, in the range of 1,000 to 25,000, can be repaid over 1 to 5 years, will normally have an attractive interest rate, and will generally have fairly strict acceptance criteria.

You'll need a decent credit rating. The lenders will be looking for a steady income, no black marks on your credit record, and probably permanent and full time employment.

These restrictions are put in place because, as an unsecured loan, you are not offering any collateral or security to guarantee that your loan will be repaid, which represents a risk to the lender, and so naturally they will only consider applications from people that won't tend to fit the profile of a 'risky' borrower.

Secured Loans

These are the kind of loans which are usually presented as debt consolidation loans, and are only available to homeowners, as the borrower's home is used as security (collateral). In contrast to personal loans, the amount you can borrow is a lot larger - right up to the value of your home, or even higher in some cases.

The repayment period can also be much longer, with 25 years being the normal upper limit. Most people choose a somewhat shorter term though, depending on the amount borrowed.

The crucial difference between secured and unsecured loans is that, because your home is offered as security, lenders are more willing to consider applications from people with less attractive credit profiles. Even if you've had severe credit difficulties in the past, you're still likely to be able to get an approval from somewhere, although naturally, the worse your credit rating, the higher the interest rate you'll be charged.

So what does all this mean in practice? The upshot is that you're likely to get a better value loan if you have good credit and go for a small to medium unsecured loan, but if you need a larger loan or have some adverse credit, and are a homeowner, then a secured loan may be the only option. As always though, you should be aware that a secured loan potentially puts your home at risk, and you should think carefully before converting unsecured debts into secured ones.