Most people take out loans with the full intention of paying back the money they have borrowed.
But the consequences of missing repayments or defaulting entirely on a credit agreement can vary depending on whether you have signed up for a secured or an unsecured loan.
Five things to do before a loan application
What is a secured loan?
A secured loan always has a specific asset as security: if you can’t repay the loan, the lender has the right to claim the asset and sell it in order to get the money it is owed.
By far the most common type of secured loan is a mortgage: people who fall behind on their mortgage repayments risk having their homes repossessed.
It is also possible to take out a further loan which is secured on your property. This is usually referred to as a second-charge mortgage, but it can only be secured against the value of any equity you have in your home – so if your home is worth £300,000 and you have an outstanding primary mortgage of £200,000, a second-charge mortgage could be secured against as much as £100,000 of equity.
Cars are another common asset used for loan security. Motor finance deals such as hire-purchase or personal contract plans are effectively secured against your vehicle, although technically speaking, you generally don’t become owner of the car under such agreements until the deal has come to an end.
How to finance a new car
Informative, in-depth and in the know: get the latest money news with Saga Magazine.
What is an unsecured loan?
Personal loans and credit card borrowing are types of unsecured loan: if you miss repayments or default, lenders have no legal right to take any of your property in order to settle unsecured debts.
Of course, this does not mean that defaulting on an unsecured loan is free of consequences: you are likely to face penalty charges and your credit record will be damaged, making your prospects of borrowing again in the next few years much more remote.
Your debt may be passed on to a debt-collection agency which could make strenuous efforts to get you to repay what you owe.
And you could have a County Court Judgment made against you.
In extreme cases you even risk being forced into bankruptcy.
Costly credit card errors
Other differences between secured loans and unsecured loans
Taking out a secured loan tends to take longer than an unsecured loan: if you are using your property as security, for example, it will need to be independently valued and there is likely to be extra legal paperwork to deal with. A personal loan or credit card can be agreed almost instantly.
Secured loans can be a cheaper way of borrowing, however: they present less risk to lenders, and this means interest rates are often lower.
You can generally raise more money through a secured loan for the same reason.
From a borrower’s perspective, however, an unsecured loan is a much less risky proposition, as the potential consequences of being unable to make repayments are much less severe.
Subscribe today for just £12 for 12 issues...
Next article: Loan types explained >>>
Enjoyed this article?
You can find more of the same in our Money hub, offering advice, tips and news on all things financial, or you could sign up for our Money newsletter to enjoy more articles like this delivered to your email inbox each week!