We discuss the difference between a secured and unsecured loan to help you understand which one's right for you.
We'll go over the following:
- what's a secured loan
- types of secured loans
- the pros and cons of secured loans
- what's an unsecured loan
- types of unsecured loans
- the pros and cons of unsecured loans
- can you get a loan?
- borrowing alternatives
- how loans impact your credit score
What's a secured loan?
It's a loan you secure against an asset you own. For example, the secured asset can be a home, hence why it's sometimes called a "homeowner loan".
The amount you can borrow depends on lenders, loan length, interest rates and your circumstances.
Lenders will also look at the available equity (value) of the asset you're securing against the loan. They assess the difference between the asset's value and what you owe on it.
For example, deducting the amount you owe on a mortgage from your home's overall value. The result gives the lender an idea of how much it’s worth, allowing them to draw up a loan against the asset.
It's essential to know the risks involved with secured loans; it can mean losing the asset it's secured against if you don't keep up with repayments.
Types of secured loans
There are a few types and names for secured loans:
- home equity loans or, as mentioned, homeowner loans – a loan where a lender secures it against your property
- first-charge mortgages - when you take out a secured loan without an existing mortgage
- second and second-charge mortgages – this is a secured loan when you have an existing mortgage. You'll need to agree with your current lender or a different one
- some debt consolidation loans – this is where you merge your debts into one loan. Read more about debt consolidation.
The advantages and disadvantages of secured loans
Advantages
- the interest rate is lower, as it's secured against an asset
- you can borrow more
- you can choose a fixed or variable rate
Disadvantages
- you could lose your home or asset its secured against if you fail to afford your repayments
- if your loan has a variable interest rate, the repayments could increase
What's an unsecured loan?
Unsecured loans (or personal loans) don't need any security. Your credit score can influence whether you can afford the loan repayments. Learn what a credit score is.
This means interest rates tend to be higher.
These loans come with a varying Annual Percentage Rate (APR) – read our APR explainer to learn more.
Types of unsecured loans
These can include:
- personal loans
- student loans
Advantages and disadvantages of unsecured loans
Advantages
- need no security, so it comes with a lower risk
- typically more flexible
- quicker and more complex, assuming you're eligible
Disadvantages
- interest rates tend to be higher
- if you don't make repayments to the lender, you're liable to pay charges, and the lender could take you to court
- failure to repay the loan on time could have an impact on your credit rating
Can I get a loan?
Your lender must be happy with your eligibility before getting a loan.
Before applying, you should consider your income and outgoings – such as your mortgage and household bills – and how these fit in with possible repayments.
You must also think about the future: what if your circumstances change?
What are the alternatives?
It's okay if neither of these are for you. Other funding options can include:
- remortgaging
- guarantor loans
- 0% money transfer cards
- borrowing from family and friends
Always ask yourself if you can pay it back, when and how.
Do loans affect your credit score?
Secured and unsecured loans can positively and negatively impact your credit score.
On the positive side, taking out a loan can give you a better credit mix, which typically boosts your score. It helps build a credit history and, if you make your payments, tells lenders you're trusted to pay back on time.
Negatively, failing to make repayments can impact your credit score. Taking out a loan means a lender will perform a hard credit check on you, decreasing your score in the short term.
Typically, if you're eligible for a loan and have planned out your payments properly, it's a good way to boost your score and build credit.
Learn about how else you can improve your credit score.
