Unsecured loans are the popular choice when people need to borrow money. Used for everything from debt consolidation to paying for home improvements, the ‘unsecured’ means that you don’t have to put up any collateral to the lender as a guarantee that you’ll pay the loan back. But what are the other differences between these forms of borrowing?
How do unsecured loans differ from secured loans?
The application for secured and unsecured loans is exactly the same. Loan amounts vary, but they are usually in the region of £5,000-£25,000 (although smaller and larger sums are also possible). You are generally eligible to borrow more if you take out a secured loan.
As far as the loan terms are concerned, the average is 1-5 years. Affordability of the monthly instalments is of key importance when specifying how long you want the loan to last. However, you should bear in mind that the longer the loan term, the more you will have to pay back overall in terms of interest.
The interest rate for unsecured loans tends to be higher than for secured loans although this might vary from lender to lender. Unsecured loans might also have a variable interest rate. This means that it is tied to the Bank of England’s base rate and so it might change during the course of your loan term. This makes it more difficult to budget successfully as loan repayments could rise. By contrast, secured personal loans tend to have a fixed interest rate so you know exactly how much the monthly repayments will be.
One of the reasons unsecured personal loans are so popular is that you don’t need to be a homeowner to apply for one of these loans as long as you can prove to the lender that you can afford the repayments. However, to be approved for a secured loan, you must have some assets such as property or a car. This gives the lender a greater sense of security if you default on your loan repayments. This is because they can repossess your asset in place of the amount borrowed.
This doesn’t mean, however, that you needn’t worry if you’re unable to pay your unsecured loan off. It is a legally-binding financial document and you will still face difficulties if you don’t pay the monthly instalments such as facing a CCJ (County Court Judgment).
Unsecured loans – researching your options
After weighing up the pros and cons of secured compared to unsecured loans, you should also consider other forms of borrowing. For instance, instead of small unsecured personal loans, a credit card might be a better financial product to meet your needs. By contrast, if you have urgent need of cash, then a short-term loan might be the best choice. Once you decide that an unsecured loan is the right product for your personal circumstances, it is time to carry out in-depth research of the loan market.
These personal loans are available from most High Street financial institutions as well as from some retailers and lenders who operate exclusively online. The choice can be so varied that it can be a daunting task to sift through them all.
One of the most convenient ways to start is by using a price comparison site. As not all lenders are present on all websites, you should use at least two of these sites to get a well-rounded picture of the market.
The site will include details about eligibility criteria, loan terms, fees, amounts as well as the APR. Although the representative APR (the total cost of your borrowing) should play a role in your decision-making, it shouldn’t be the sole criterion for a number of reasons.
Firstly, APR can vary – not only from lender to lender but also from borrower to borrower. According to financial regulations, lenders only have to offer this rate to 51% of loan applicants. There is a chance that you will be quoted a higher rate.
Another way that the APR can vary is according to how much you borrow. The way that financial institutions structure the interest rate is via loan thresholds. If your loan amount saddles this threshold, it might be cheaper in the long run to borrow slightly more than you need. Before deciding to do this, you should think about the implications of this as it could lead to greater indebtedness and for much longer.
Apart from the APR, you should consider other features of the unsecured loan. For example, some lenders offer a payment holiday which can be convenient when times are hard. You should also ensure that you are borrowing money from a reputable lender. They should be authorised and regulated by the Financial Conduct Authority (FCA). If you have any doubts about the lender, the FCA has a financial services register of all firms which can offer consumer credit facilities.
The application procedure for unsecured loans
Before applying for an unsecured loan, it is a good idea to first use the lender’s online loans eligibility calculator. After entering your personal and financial information, it is able to inform you whether you meet the firm’s lending criteria. This way, you avoid your loan being rejected.
During your application for an unsecured loan, lenders will request detailed information about your personal and financial circumstances. This process involves verifying your identity (with reference to photo ID and your presence on the electoral register) and consulting your credit score. Contacting one or more credit reference agencies gives them an idea of your credit history and overall indebtedness.
All lenders are legally required to check that you can afford to pay back the loan. To assess affordability, they will consider your income as well as your daily expenditure including expenses for housing, bills, etc. They will probably request copies of your bank and/or credit card statements so they have a clearer picture of your spending habits.
Once you have received your unsecured personal loan, you have a 14-day cooling-off period during which you’re allowed to cancel the loan agreement at any time and without incurring any penalties.
Are there unsecured loans for bad credit?
If you have a poor credit score, one solution could be to ask someone to act as a guarantor for an unsecured loan. They must be aware that they will assume responsibility for loan repayments if you cannot. If this isn’t possible, unsecured personal loans for bad credit and with no guarantor are still possible. However, you may find that there is a limited choice of lenders. There are some firms (the majority online) which specialise in unsecured bad credit loans.
If you have a poor credit score, one solution could be to ask someone to act as a guarantor for the loan.
Another drawback is that because you represent a greater risk for the lender, then your borrowing will be much more expensive with a higher APR. Unsecured loans for bad credit are often used for debt consolidation. Although it reduces your monthly loan instalments, the longer loan term means that you will be paying much more back overall.
Making repayments on unsecured loans
It is imperative that you set up a direct debit so you avoid delayed and/or missed payments and incur additional charges on your unsecured loan.
If you have any worries about paying back your loan, it is crucial that you let the lender know as soon as possible. If possible, explain what steps you’re taking to remedy the situation and when you expect to be able to pay the instalment. Different firms have different procedures when dealing with defaulting borrowers, but all of them will charge you extra. Another disadvantage is that missed payments will also be recorded on your credit file and have an impact on your credit rating.