Loans taken out by most individuals in the UK tend to fit neatly into two categories:
- Residential mortgages are a form of personal loan which is secured on a property.
- Unsecured credit, such as credit cards, overdrafts, and short-term cash loans
This binary view of the lending market actually minimises the role that secured loans have to play in providing personal finance to individuals. Secured loans actually come in different shapes and sizes, with residential mortgages being only one type of secured loan offered by organisations.
In this article, we’ll look at the common types of secured loans outside of mortgages, and highlight when a secured loan may be a favourable option to unsecured debt.
What secured loans are available?
We are all familiar with a mortgage. The word ‘mortgage’ technically refers to the legal claim placed upon a property as security by a lender when the loan is taken out. It gives the lender the right to seize possession of the mortgaged building in the event of a default on the loan.
These same claims can be placed upon any asset in theory. Lenders prefer assets of value, which can be easily resold to free-up cash to repay the loan. In practice, this means that vehicles, static caravans, a portfolio of stocks & shares, and an insurance policy could all qualify as assets that can ‘secure’ a loan.
When should you pick a secured loan?
Offering collateral to a lender or bank may feel like a big commitment. In what circumstance could it be advantageous to choose this type of loan over a credit line without any specific claims to your assets?
Secured loans will generally quote a lower rate of interest (known in the UK as an APR) than unsecured loans because the lender is taking less risk. This means that there are two scenarios where secured loans could have a meaningful impact on the total cost of your purchase:
Long term borrowing
If you need to borrow funds for the long term, offering security is often a worthwhile inconvenience because over long periods of compounding even a small saving on interest rates can have a huge impact on your total borrowing cost.
If you borrowed £10,000 for five years with an APR of 12% (unsecured), you would pay a total of £13,161. That equates to £3,161 in interest on top of the repayment of the original sum borrowed.
However, if you could obtain a secured loan with an APR of just 8%, you would pay only £12,085 over the life of the loan. That’s a saving of just over £1,000 or 10% of the original loan value.
Large lump sums
A lower rate of interest available via a secured loan could also make a large difference when borrowing large sums, such as £50,000 to extend your home.
A trivial 1% difference in your interest rate would result in a £500 impact on your annual interest bill. That could be enough money to pay for a restaurant meal for your entire extended family!
