Unsecured or secured loans

September 20, 2011

Personal loans serve many purposes, from financing a new car to consolidating existing debts. Two types of personal loan are offered to consumers: secured and unsecured. Although similar in many ways, secured and unsecured debts are notably different when it comes to enforcing terms should the borrower default on repayments.

Secured Loans

The secured loan is one that uses an asset of the borrower as security for the loan. In the vast majority of secured loan applications, the borrower will agree to offer his home as security; therefore, secured loans are only available to homeowners.

To secure a loan against a property is to attach a risk to it. A secured loan requires sufficient equity in a property – a figure that can be calculated by deducting the amount of an outstanding mortgage from the value of the property – because the lender requires assurance that the loan can be repaid. In finance, property ownership offers no greater assurance to lenders that a debt can be satisfied if the borrower defaults on repayments because the equity in the building can be used to clear the outstanding balance.

Obviously, this means that the borrower could lose his home if he happens to default on repayments. This fact may surprise those who think secured loans mean lower risk to the borrower; on the contrary, a secured loan provides security to the creditor, not the person whose home is on the line.

A secured loan is not necessarily the best option for all homeowners. In many cases, it is financially more prudent for borrowers to remortgage a property for a larger sum of money at a lower rate of interest than it is to obtain a secured loan. This is not to suggest, however, that secured loans are not viable for consumers; indeed, a secured loan is useful and sometimes the most cost-effective option if a person requires £25,000 or more over a relatively long period of time.

Unsecured Loans

An unsecured loan is simply a loan to which no equity is attached. Unsecured loans, therefore, are ideally suited to people who do not own property; however, there is nothing to stop a homeowner from acquiring an unsecured loan (in fact, this is often the better option than obtaining a secured loan).

Unfortunately, because unsecured loans tend to be more risky for lenders, they tend to be limited in terms of the amount that can be borrowed; furthermore, unsecured loans will almost certainly be subject to higher rates of interest than secured loans. It may be preferable in some cases to apply for an introductory 0 per cent balance transfer credit card instead of an unsecured loan if the main objective is to clear outstanding credit card debts or to make a one-off purchase.

Unsecured loans also require a relatively good credit rating of applicants, so levels of borrowing will be limited by an individual`s credit history. Applicants with excellent credit can often acquire unsecured loans up to around £25,000 at relatively good rates of interest (4-8 per cent APR).

It should be noted at this point that defaulting on an unsecured loan does not necessarily mean a homeowner would escape the consequence of losing his home. In some cases, a creditor can apply to the court for a charging order to be placed on a property, which ensures that the outstanding balance of the loan is paid before other funds are released. If the charging order is granted, the creditor can then apply to force the sale of the property.

In conclusion, a secured loan is sometimes more risky for the borrower than an unsecured loan, but the former often attracts lower interest rates and more flexible repayment options than the latter. People who have experienced debt problems in the past may wish to apply for a specialist loan for bad credit, which may be secured or unsecured.

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