We break down the differences between secured and unsecured loans, their risks, and what they're commonly used for.
When you borrow money using a secured loan, you are pledging a valuable asset as collateral. This asset can be seized by the lender as compensation if you're unable to repay the loan back.
Property can be used as secured collateral for home loans. Cars, life insurance policies and even gold can be used as security for other non-mortgage secured loans. For this reason, the interest rates on secured loans will usually be lower than the rates for unsecured loans, and you may be able to borrow a larger amount.
The amount you can borrow for a mortgage – which is a type of secured loan – is based on a number of factors. These may include:
The maximum amount you can borrow for a home loan may also be dependent on your loan-to-value (LTV) ratio. This is the ratio between the value of your loan and the value of the property.
Secured loans are often used for:
If you're applying for a secured home loan, you're required to buy collateral insurance for your property for a minimum of 5 years up to the duration of the loan tenure.
If you use a valuable asset such as your home as a form of security, the lender could repossess and sell the property if you default on the loan.
The main difference with an unsecured loan is that the lender won't ask for collateral as security. This means they can't seize your assets if you default on the loan. However, any late or missed repayments can negatively impact your credit score and you may find it difficult to borrow money again.
The interest rates for unsecured loans can be high. These vary between lenders and the type of loan you're applying for. Amongst other things, a lender will look at your income and what you'll be using the loan for when deciding if they're willing to lend to you. A poor credit score will typically mean you'll be charged higher interest on your loan.
An unsecured personal loan can be helpful if you need to borrow money to pay for:
Late or missed equated monthly installments (EMIs) can bring your credit score down. Both the loan and the property may be recalled, and you may find it difficult to borrow money in the future.
Learn more: 5 ways to improve your credit score
Before you apply for a loan, consider what you need it for and if there's another way to save money. Assess whether you'll be able to repay the loan, and do your research. It's a good idea to seek independent professional tax advice for any tax-related issues and implications on/of your loan.