In our ‘what different types of loans are available’ article, we identified that secured and unsecured debt are popular forms of borrowing. But which is the cheapest way to borrow? Which is the most flexible? In this article, we will compare and contrast the typical characteristics of secured and unsecured borrowing to help you reach a decision. Remember that even the cheapest loan can be a bad financial decision, and the choice of whether to borrow or not should not be undertaken lightly.
A loan is classed as ‘secured’ if collateral is given to the lender when borrowing a sum of money. This security gives the lender more confidence that they will recover the loans on their books, and therefore secured loans are generally closer.
Conversely, unsecured loans are made without the lender taking any collateral.
The interest rates of secured and unsecured loans are measured with the Annual Percentage Rate (APR), this is an imperfect but apt measure of the actual interest charges you will incur over the year. The Annual Equivilent Rate (AER) is an exact measure, and is usually higher than the APR, but lenders are only required to state the representative APR of their loans (UK only). The difference is only small, and therefore APR is a reasonable figure to use to compare the interest costs of borrowing.
Secured Loans vary between 5% and 40% APR
Unsecured Loans vary between 6% and 2,500% APR
Unsecured loans take in account your credit profile, whereas secured loans take into account your credit profile as well as the quality of security you can give them. If you can offer a house that you fully own as security then you will be able to access the lowest rates.
Fees & Other Charges
Due to the paperwork involved in legally assigning security to the lender, secured loans can carry hefty initial fees, similar to mortgages. These fees can sometimes be called ‘broker fees’ or even ‘lending fees’, and vary considerably.
Fees are usually not charged upfront, as this is synonymous with advance fee fraud, and therefore reputable lenders steer clear of upfront fees to avoid sending out the wrong message. Genuine fees are usually added onto the amount lended (or subtracted from the cash received).
Due to the differences in fee structures of different lenders, it is difficult to make a firm expectation of fees comparison, however secured loans are longer term and involve more paperwork and therefore carry higher fees.
One defining difference between secured and unsecured loans is the speed of applications. Due to the simplicity of an unsecured loan, small and high interest loans such as payday loans can be applied for online or in-store and issued within 1 hour, which is mind boggling compared to 30 years ago. This means unsecured loans are much faster than secured loans. This is possible because with high interest loans, full credit checks are not necessary and the loan is effectively ‘secured’ against your next salary, by way of a direct debit timed to come out as soon as your wage enters your bank account. This clearly shows that unsecured loans can be obtained faster secured loans.
With such a range of loans on market, flexible loans can be obtained in both secured and unsecured varieties. Flexible loans allow you to pay off the loans early with minimal or zero charges for early repayment.
Historically speaking, secured loans carried higher brokerage and paperwork fees, along with more draconian terms & conditions and this made them an option of last resort. But interestingly, despite the fact that secured loan applicants are therefore likely to have been turned down elsewhere, you are more likely to be accepted for a secured loan than almost anything other type of loan. This is because the security given to the lender reduces the negative effects of a bad credit profile. Therefore your chances of being accepted for a 17.9% secured loan is far higher than a 17.9% unsecured loan.
If you are in need of medium/long term finance then I would encourage you to cast your net as wide as possible to search for the best deal, therefore if you have property to secure a loan against, it may pay to at least look into both types of loan, so that you can weigh up the real costs of both types of loans.
If the interest charges and other fees taken together are similar for both secured and unsecured loans, then the unsecured loan will be your most advantageous option, because unsecured terms have a lesser claim on your property should you struggle with repayments.
As a final point, it is worth remembering that to default on either type of loan could result in legal action being taken against you to reclaim the amounts owed. For a secured creditor, this will involve repossession. For unsecured loans this may take the form of a bankruptcy.