You may have heard of secured loans and unsecured loans, but what exactly is the ‘security’ that they reference? Let’s take a closer look...
Security for the lender
When a lender lends you money, they’re taking a risk. Borrowing is a contract and you both have to agree to keep up your side of the deal (the lender to provide you with the money you’ve applied for, and you to repay it) but there’s always a risk you may not repay them.
Because of this, lenders try to limit the risk they’re taking in a number of different ways.
One way is to charge you for the money you’re borrowing. This is known as interest, and most forms of borrowing come with an interest rate.
With a loan, you agree the interest at the start of your agreement, and your repayments will include this. With a credit card, you also know the interest upfront, but if you clear your credit card balance in full within each month, you won’t have to pay any interest at all. Find out more about this here.
Generally speaking, credit cards and personal loans let you borrow relatively small sums of money (although it may not feel like a small sum to you). They are both unsecured forms of borrowing.
If you want to borrow more, say, to complete a big home improvement project, the lender may want to take more steps to reduce the risk they’re taking. They do this by using something of yours as security. If you stop making your repayments on the loan, you have not kept to your side of the agreement, which means the lender is legally able to take whatever you used as security away from you.
What can be used as security?
Among the best-known secured borrowing options is the homeowner loan. It’s called this because it’s only available to homeowners and is attached to your property (it’s also sometimes called a second-charge mortgage).
If you stop making your loan repayments, the lender is legally able to repossess your property. They will then sell it in order to get back the money you owe them.
But what about if you already have a mortgage attached to the property? In this case, the proceeds of the property sale would go first towards paying off your mortgage and then towards clearing your homeowner loan. Anything that’s left goes to you – but if there’s not enough to clear the loan, your lender can carry on chasing you for money.
It’s for this reason that you should think carefully before taking out a homeowner loan and be certain you can keep up with the repayments.
Your home is not the only thing you can use as security on a loan. A logbook loan is a loan that’s secured to your car. If you stop making repayments, the lender can repossess your vehicle.
You can find out more about logbook loans here. This area of the lending industry is not heavily regulated, which makes it a risky option for borrowers.
There are also lenders out there who will offer you a loan secured against a different valuable item you own. This might be a designer watch, a painting, or a piece of jewellery. You may be more familiar with this type of lender when you hear its other name – a pawnbroker.
A pawnbroker may offer you the choice of either selling your valuables for cash or using them as security for a loan. With the latter option, you will be given a time in which you must repay the loan and if you don’t they may sell your item.
You must think very carefully before applying for a secured loan. Whichever type you choose, something you own will act as security and if you don’t keep up with your repayments, you risk losing it. This could put you in a particularly difficult situation if it’s your home or car that’s at risk.
However, providing you only borrow what you can afford and never miss a payment, a secured loan could provide you with the money you need and a way to pay it back in affordable instalments.
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