Looking for a personal loan to help you afford that holiday, buy that car or start that business? As well as thinking about how much you plan to borrow, and whether you can afford the repayments, it’s important to consider the security requirements of different personal loans.
While some lenders require a security deposit or some other collateral when you apply for a personal loan, other lenders require no such guarantee from a potential borrower. Working out whether a secured or unsecured personal loan is more suitable for reaching your goals will depend on a range of factors, including your household’s budget and unique financial situation.
Secured personal loans
Just like how most mortgages require the borrower to pay a security deposit up-front to guarantee the loan, several personal loans also require the borrower to provide financial security to help protect the lender in case the borrower defaults on the loan.
While you can pay a cash deposit to secure a personal loan much like a home loan, many personal loans can also be secured by other assets, such as a car, equity in a property, or valuable art or jewellery. Many car loans are structured as secured personal loans, using the value of the vehicle being purchased to guarantee the loan.
Secured personal loans tend to have lower interest rates, as the security helps to protect the lender against the risk of the borrower defaulting. Secured loans can also appeal to borrowers with bad credit, as the extra security can help to reduce their risk to a potential lender, and help improve the likelihood of their loan application being approved.
The primary risk with a secured personal loan is that if you can’t pay back the loan and default, you’ll lose your security, whether that’s a cash deposit, your car, or your property – the lender will repossess and sell the asset to make up its losses. Defaulting on a loan is already bad news for your credit rating, but losing the car you use for work, or even your home, can further complicate your situation.
Unsecured personal loans
You don’t always need to provide security for a personal loan. Several lenders offer unsecured personal loans, where you can borrow money without requiring an asset as collateral.
The benefit of an unsecured personal loan is that you won’t need to put one of your assets at risk. If you default on an unsecured personal loan, the lender will take legal action to recover their money, and your credit rating will take a hit, but you won’t automatically lose your car, house, or other assets.
Unsecured personal loans can also be useful for borrowers who have financial goals, but don’t have appropriate assets available to use as security. For example, some car loans only let you use new cars of particular makes and models as security, as used cars are unlikely to retain enough value to cover the loan’s cost in the event of a default. So while it may sometimes be tricky to buy a used car with a secured loan, an unsecured loan may be more helpful.
On the other hand, unsecured personal loans tend to have higher interest rates than their secured counterparts. This is because without a security deposit, the lender is at greater financial risk if the borrower should default, meaning the lender will likely charge the borrower more in interest to cover their costs.
Also, because these loans tend to be riskier for lenders to provide, a borrower will often need a strong credit rating and clean credit history to successfully apply. If you already have significant debt, or have had credit troubles in the past, it may be more difficult to successfully apply for an unsecured personal loan.