Ever wondered why banks lean towards secured or unsecured loans? Let's dive into the world of loans, exploring the details behind their choices.
Secured vs unsecured loans: An in-depth analysis
When you start thinking about taking out car finance, you may hear people talk about secured and unsecured personal loans. But what are personal loans and what’s the difference between the two types of personal loans?
Firstly, a personal loan is an amount money you borrow in a lump sum for personal intentions like debt consolidate, home improvements or cars for example. You pay it back in instalments over a fixed term and usually with a fixed rate of interest. This is different to other types of loans which include;
· Homeowner loan
· Credit cards
· Student loans
· Payday loans
The main difference between a secured or unsecured personal loan is the presence or absence of what banks call collateral, an asset which is owned by the customer, and the lender can recover in the event of the customer defaulting on the loan. An asset can be pretty much anything of value like a house, a vehicle, or even a boat if you owned one.
Definition and characteristics of secured loans
As we’ve mentioned above, a secured loan is one that’s attached to an asset that the bank can recover in the event of the customer defaulting. But what are the other characteristics of a secured loan?
A secured loan is usually offered over a much longer period given the reduced risk to the lender. It and will also generally be offered at a lower interest rate given the longer period and the security of the asset underpinned against it.
The amounts offered as a secured loan will be considerably higher than those offered as unsecured.
Definition and characteristics of unsecured loans
By contrast an unsecured loan is one that does not have any collateral attached to it. It will usually be offered over a shorter period than a secured loan.
The interest rates will also be higher than a secured loan. They represent a more popular loan type for relatively small scale borrowing. The penalties for early repayment will usually be less than that of a secured loan.
One of the key advantages is you don’t need to offer up anything as means of collateral.
One of the characteristics of secured is that it is usually for larger amounts, it would be good to mirror this in the section above.
Key differences and considerations
Common uses and potential drawbacks of both products
Unsecured loans
An unsecured personal loan doesn’t come without its risks to the borrower as well as the lender. There may well be additional charges if you miss a payment, impacting your credit score and a damaged score could potentially impact your ability to obtain future borrowing.
Despite the fact it is not linked to an asset, in the event of the borrower defaulting the lender can still recover their costs through the courts if that became necessary. So you still need to think just as carefully about the affordability of any unsecured loan.
Secured loan
A secured loan is usually used when you need to borrow larger amounts at a lower APR or when your credit score doesn’t meet the threshold for an unsecured loan.
The asset that you offer as security, normally your home, is at risk if you don’t keep up repayments so you need to be confident that this type of borrowing suits your current and foreseeable future circumstances.
Bank Decisions: Is car finance an unsecured loan?
In short, no. Car finance is not the same as an unsecured loan.
The term car finance covers the various options to finance a car. Only when the finance has been paid back, together with the relevant option to purchase fee or balloon payment, is the car yours.
This shouldn't be confused with the generic unsecured loan product which can be offered as a way to buy a car.
The following gives a quick overview of the different types of car finance and you can find more in our car finance guide Guide to Car Finance | Oodle Car Finance
PCP
This type of finance is essentially renting the car for a period of time, paying in instalments, at the end of the agreed period you can either hand back the car, pay a balloon payment or put any equity into a new arrangement.
Hire purchase (HP)
HP offers a way to use the vehicle while you are paying off the finance in instalments. Ownership of the vehicle will transfer to you following the final payment and an option to purchase fee.
PCH
With PCH you have no option to buy the car but you are leasing it long term. At the end of the agreed period you hand back the car.
Factors Influencing banking choices.
The decision to choose one type of loan over another will not be driven by the bank but the choice you make will be dependent on your circumstances.
Subject to ID and proof of address, if you have a decent credit score and are in full time employment you can usually be considered for an unsecured loan. To choose a secured product you will need to be a home owner (if that is the asset you are using) with a certain amount of equity in the property. In all cases, the final APR, amount, and duration you’re offered will be subject to an assessment of your individual circumstances, including your credit rating. To find out more about your credit score, you can look here Credit Scores | Oodle Car Finance.
Making good financial decisions
Whether you choose an unsecured or secured loan to buy your car, you will need to satisfy your lender that this is affordable for you. If you are choosing a secured product, then you need to manage the risk associated with the potential loss of the asset used as security in the event of you not being able to pay back the loan.
In all cases, shop around and use the APRs across the loan landscape for comparison. Use the soft search to get a good idea of the rates you could be offered. You can use free services to monitor your credit score and have an idea of what products are likely to be available to you. Use an online finance calculator Personal Loan Calculator – Work Out Your Repayments – MSE to test different timeframes, deposits and amounts. If you do your homework and get the right loan for you, it can be a great way to meet your financial goals.
