Secured loans are becoming increasingly popular, particularly among those who own their own home and want to borrow a more substantial sum but may be struggling with an impaired credit rating. A secured loan is exactly as it sounds: you borrow money and the loan is secured against your property – so you have to be a homeowner.
In a bad credit situation secured loans generally come with lower interest rates than with sub-prime unsecured loans. That’s because the lender is exposing itself to less risk – it has the value of the home to fall back on in extreme circumstances. But this also means that tenants, people in social housing and many others in shared-ownership schemes are not eligible for secured loans.
Don’t confuse a mortgage with a secured loan: the former is known as a ‘first charge’ while the latter is a ‘second charge’ and this difference becomes relevant if the borrower become unable to repay the loans (see below).
What Secured Loans are available?
Secured loans are offered for variable interest rates and for variable amounts. Some lenders will offer loans of up to £25,000 while others offer much higher sums: often as much as £250,000. The main difference between a secured loan and a mortgage is that with a secured loan you usually have to have a certain amount of equity in your house (the difference between a home’s value and its outstanding mortgage balance). With a mortgage, you have to put down a deposit although this can be equity if you are selling your property and buying another one.
As with mortgages, the lender will conduct an affordability test to ensure that you can continue to make repayments in the future so you will need to be able to show that you can continue to cover the new loan, your mortgage repayments and any other outgoings.
Interest rates vary and tend to be lower for those borrowing higher amounts. The cheapest secured loan rates are currently between 8 and 10% while the more expensive can be anything up to 20%. You are more likely to have to pay a higher interest rate if you are borrowing a small amount or you have a poor credit record.
What if you can’t meet your Secured Loan repayments?
The big risk to be aware of is that if you default or otherwise fail to keep to the repayment schedule, the lender may be able to apply for a court order to take possession of your house and sell it to cover the outstanding amount that you owe.
When somebody gets into financial difficulty and the matter ends up in court, the mortgage issuer has first call on the house while the secured loan lender has second call. This is a legal arrangement and all charges are registered through the Land Registry. But while the priority with which delinquent loans against property are dealt with is different, the terms are usually exactly the same and are both regulated by the Financial Conduct Authority.
Are there any other pitfalls?
While you will often be able to borrow money for a fixed rate (which is usually for a set number of years), with most secured loans, you will find that interest rates are typically variable, which may cause you difficulties if rates rise significantly in the future. That means that if you also have a variable rate loan, you could struggle if the current era of record low interest rates suddenly comes to an end.
That might sound like an extreme scenario but it’s worth remembering that you are exposing yourself to a higher risk with a secured loan than an unsecured one. When deciding if you want a secured loan, there are some important questions you should ask yourself:
How long will I have to repay?
Secured loans come with repayment terms of between five and 25 years. Some do have longer schedules, though, with a few lenders happy to consider repayments over 30-35 years.
Are there other fees?
In many cases, yes. Most lenders will be clear about how much they charge and what fees and administration charges there are. But some continue to borrow these conditions in the small print of the terms and conditions. Watch out for arrangement fees, other admin charges and, particularly, early redemption fees. If your circumstances suddenly change for the better and you are in a position to pay off your loan early, then redemption penalties will mean that you will have to find extra money to pay off the balance and close the loan.
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