Loans taken out by most individuals in the UK tend to fall into two categories:
- Residential mortgages are a form of personal loan that is secured against a property.
- Unsecured credit, such as credit cards, overdrafts, and short-term cash loans
This binary view of the loan market actually understates the role that secured loans should play in providing personal finance to individuals. Secured loans actually come in different shapes and sizes, with residential mortgages being just one type of secured loan offered by organizations.
In this article, we’ll look at common types of secured loans besides mortgages and highlight when a secured loan can be a favorable option over unsecured debt.
What secured loans are available?
We all know a mortgage. Word ‘mortgage’ technically refers to the legal claim placed on a property as collateral by a lender when the loan is taken out. It gives the lender the right to seize possession of the mortgaged property in the event of loan default.
These same claims can be placed on any asset in theory. Lenders prefer valuable assets, 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 and shares, and an insurance policy could all be considered assets that could “secure” a loan.
When to choose a secured loan?
Providing a guarantee to a lender or a bank can seem like a big commitment. In what circumstances could it be advantageous to choose this type of loan rather than a line of credit without any particular claim on your assets?
Secured loans will usually give a lower interest rate (known in the UK as APR) than unsecured loans because the lender takes on less risk. This means that there are two scenarios where secured loans could have a significant impact on the total cost of your purchase:
If you need to borrow funds long-term, offering security is often a valid drawback, because over long capitalization periods, even a small savings on interest rates can have a huge impact on your cost of financing. full loan.
If you borrow £10,000 for five years with an APR of 12% (unsecured), you’ll pay a total of £13,161. This equates to £3,161 in interest on top of repaying the original sum borrowed.
However, if you could get a secured loan with an APR of just 8%, you would only pay £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 interest rate available through a secured loan could also make a big difference when borrowing large sums, such as £50,000 to extend your home.
An insignificant difference of 1% 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!