When you're looking for a personal loan, you'll see that you can take out either an unsecured or an unsecured one. It's important to understand the difference between the two types of loan before you apply as each one has its particular advantages and disadvantages, which may or may not suit you and your needs.
No matter what your loan is for - home improvements, a once-in-a-lifetime holiday or to consolidate a number of smaller loans under one single interest rate - you should take the time to compare market offerings before choosing a product you like.
The main difference between the two forms is that when you take out a secured loan you have to back it up with an asset as security for the lender. If you fall behind on your repayments, the lender can repossess the asset and sell it to recoup some or all of the outstanding money.
Sometimes, the security or asset is actually the thing that you're buying with the loan - a good example is a car loan. You borrow the money to pay for it and while you're paying down the loan, you're using the vehicle as security.
This is seen as a good risk for the lender because if you fail to make the payments, they can take the car back.
Examples of assets that can be used as security
You can't use just anything as loan collateral; if you're only borrowing $5,000, for example, then you'll usually need to roughly match the amount of loan with the security. You can use:
- Vehicles, including new and used cars, boats, caravans and motorbikes; you can even use things like jet-skis
- Property, or equity that you hold in a mortgaged property; this may be more suitable for larger loans
- Term deposits, if you're using the same provider as you are for your loan, they may accept the deposit as security, and
- High-value assets like jewellery and fine art; you'll have to have these independently valued before you apply for the loan, which can take time.
Which type of loan suits you best?
Here's how you work out your best option
If you're looking for a loan to buy a vehicle then you need to look at how old the vehicle is because some lenders will only accept cars under two years old as collateral. If you're buying an older car your lender may want an inspection before agreeing to the loan, but there may still be age limits - usually seven years or so - for the vehicle. In these circumstances you may have more success with an unsecured loan, although the interest rates will be higher.
The purpose of your loan also determines how much you can borrow and whether unsecured or secured is better for you. With secured loans, lenders can place conditions on the agreement; for example, if you're looking for a car loan you probably won't be able to tack on an extra $1,000 for cosmetic customisations on the amount. If you can do without the customisations, then go for secured; if not, unsecured may be better. You can always add on your extras later, at your own cost.
Comparing secured and unsecured loans
No one type of loan is better than the other; it's a case of seeing what suits your budget and your needs most at the time. Here's some other things to consider when you're looking for personal loans.
The interest rates
A secured loan is less risky than an unsecured one, so you'll often find that the interest rates are lower. This reflects the fact that the lender isn't going to lose out if you default on your payments because it has recourse to repossession.
There's not much difference in set up and ongoing fees between the two types, it's more a case of comparing different providers to select the best deal for you. Always be careful to look at the comparison rates of loans, as these include the fees, so you'll know exactly how much your loan will cost you in total.
The flexibility of repayments
If the loan is fixed rate, you'll probably find there are penalties for overpayments or early repayment. Flexible rate loans tend not to be so strict so if you think you'll be able to pay down the loan earlier, look at flexible rates. As ever, always read the small print.
The term lengths
Most loans range from one to five years for fixed rate and one to seven years for variable rate.
The purpose for the loan
Unsecured loans can be used for most purposes (within reason), whereas secured loans tend to have restrictions. If you're buying a car with a secured loan, the lender will not want you to buy anything else with the funds.
Before you apply...
Think about affordability
Can you afford the repayments each month? This is one of the fundamental things to think about. Use a loan calculator to work out how the monthly repayments will fit into your budget, as well as whether it's worth making overpayments now and again.
How much leeway do you have with your loan?
If you just want to make one purchase for a definite amount, then a secured, fixed rate product might be your best bet. If the loan is for home improvements and you're not 100% sure exactly which jobs you'll be doing, an unsecured loan is best. Home improvements take time, so you'll probably use money from your salary and your savings somewhere along the way as well.
Ultimately, the type of loan you apply for all depends on what you're buying and how you're going about it, as well as how much you can afford each month. This is one of the reasons why you need to find out as much as you can about the different products out there and how they'll work for you.