Secured v unsecured debt: understand the difference

  • August 16 2016
  • Ben Emerson

Any financial organisation will have only one concern when deciding whether or not to lend you money and that is whether you can afford to pay it back. How they work this out can depend on what type of loan you apply for, what your personal circumstances

Secured vs unsecured debt

Whether your loan is to be secured or unsecured can be a determining factor as to whether your application will be approved or not.

What are unsecured loans?

Personal loans and credit cards are types of debt that are 'unsecured', which simply means that they are not linked to any tangible asset: lenders loan you money based on faith that you will repay it (and have the means to do so). That ‘faith’ is based on your credit report. If you were to apply for a personal loan or credit card, the lender would look very carefully at your credit history. They will want to see a healthy credit report going back several years with no black marks (such as County Court Judgements, CCJs) against your name and a solid history of reliable and prompt debt repayment. They may also look at your social score report (which is derived from your use of social media, and is a good indicator of personality and lifestyle, both of which have been shown to be accurate indicators of debt repayment habits). They will not usually carry out an interview or ask you questions in your application about the details of your monthly income or outgoings.

Will you be granted an unsecured loan?

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Based on your credit report and/or social score report, if the lender is satisfied that you are likely to repay your debt (because you have strong scores) they will agree to give you a loan and may well offer you a low interest rate so that you will choose to borrow from them, rather than from one of their competitors. On the other hand, if a lender thinks that you will default on your repayments (because you have done so in the past, for instance) then they may decline your loan application or else only approve it with a hefty interest rate attached to make up for the risk of non-payment. You can check your own credit report and social score report with Credit Angel to see how you would be viewed by a lender.

Defaulting on an unsecured loan

If you don’t pay back an unsecured debt, the lender can take you to court and force you to do so – this will result in you receiving a CCJ against your name, which will make it very difficult to get credit in the future and will show up in any credit check run by lenders and even employers. The CCJ will order that you repay the debt and if you do not do so within the time specified, court bailiffs can be instructed to come to your home and remove goods to the value of the debt owed.

What are secured loans?

Mortgages are an example of a secured loan; hire purchase is another form of secured loan. The former involves borrowing money with which to buy a house and the latter is used to buy a car. In both cases, the lender only agrees to lend the money if you agree that they will have the right to sell (or take back) the house, or car, if you do not keep up with your repayments. In the case of a mortgage, a lender’s details would be entered on your property’s title deeds (the documents that prove that you own the property) so that if you ever decided to sell it, they would have to be notified and could either consent to, or refuse, the sale. They would only agree to allow you to sell the property on the condition that you use the purchase money to repay the mortgage. In the case of a hire purchase agreement, the lender will pay the car dealership for the car and will own the car until you have repaid the debt in full. You cannot sell a car that is under a HP agreement unless the HP company agrees.

Will you be granted a secured loan?

The lender will still check your credit report and possibly your social score report, but they will also probably ask you some more details about your personal finances. Certainly, in the case of a mortgage lender, they are obliged to ensure that you could afford the repayments even if interest rates were increased. Since April 2014, this has been a legal requirement after the Financial Conduct Authority brought in new rules to try to reduce the number of people who were falling into unaffordable debt. As their money is secured on a physical asset (e.g. your house or car), then if you were to default on your loan repayments the lender knows that they will at least have an asset to sell or take back. With unsecured debt, the risk is that a borrower who has failed to repay their loan simply has nothing with which to pay – the bailiffs may come back empty-handed – but with a secured loan, there will always be something of value that can be recovered. This is part of the reason why interest rates are usually lower for secured loans than they are for unsecured loans – because there is less risk involved for the lender.

Defaulting on a secured loan

If you do not repay a secured loan, the lender can take steps to recover the asset (e.g. the house or car). A mortgage lender would have to go through court to do this, and so might an HP provider (depending on how much of your debt you had already repaid by that time). If you still owe money then the court can order that you have to pay it back however you can. Whether you opt for a secured or unsecured loan, make sure you can truly afford to repay it each month and try to get the best deal you can on interest rates to help with affordability. Taking steps to improve your credit score and/or social score report can improve your chances of being approved for a loan and may also reduce the rates of interest you will be offered on loans.

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