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What’s the difference between secured and unsecured loans?

When you borrow money, it can either be “secured” against an asset like your home if you own it (which is how a mortgage works) or it can be “unsecured” which means there isn’t a specific asset you automatically forfeit if you don’t repay the money. Car loans and mortgages are types of secured loans. Personal loans and short-term or “payday” loans are unsecured loans. Not repaying any type of loan will damage your credit rating and affect your chances of getting a loan or another type of credit, like a credit card.

What are the main types of loan?

Personal loans. This is when you borrow a fixed amount of money – usually several thousand pounds – from a bank or another lender and repay it in monthly instalments. Personal loans aren’t secured against an asset you own. Interest rates can be fixed or variable. These loans are typically used when you want to make a big purchase and spread the cost over time. If you can pay with a credit card that offers a long interest-free period, that’s a cheaper option if you repay within the interest-free period.

Short term loans. Also known as payday loans as they’re designed to tide you over until payday, these are unsecured loans that come with a very high interest rate and are meant to be repaid quickly – from one week to usually no more than six months. They are are a last resort and are not for any long-term borrowing. There’s more about alternatives to payday loans in our guide or at moneyadviceservice.org.uk.

Guarantor loans. If you haven’t got a good enough credit score to qualify for a loan, one option is to ask a close friend or family member to act as a guarantor for your loan, meaning they become legally obliged to step in and pay it if you can’t.

Debt consolidation loans. This type of loan is for people who have several debts and want to combine them into one, with the aim of getting a lower interest rate and making monthly payments a bit more manageable. The type of debts that people typically combine are on credit cards, overdrafts and finance deals. There are lots of factors to consider if you want to consolidate. Before anyone opts for a debt consolidation loan, they’ll usually consider a balance transfer credit card with an introductory interest-free period as this is likely to be cheaper.

Mortgages. Unless you’ve got hundreds of thousands of pounds stuffed down the back of the sofa, you’ll probably need to borrow some money if you want to buy a property. A mortgage is a loan typically from a bank or building society that’s secured against your flat or house, meaning you can lose the property if you don’t keep up the payments. The loan usually lasts for between 25 and 35 years and payments are typically monthly. They can be at a fixed rate of interest, or a variable rate – or start fixed and become variable.

Car loans. There are four main options for financing your new set of wheels. You can use a personal loan or a credit card. There are also two more specialist, secured loan options. Hire purchase (HP) typically involves paying at least 10% of the car’s value upfront, and then paying off the rest over one to five years. With the second, personal contract purchase (PCP), you’re essentially taking out a loan for the difference between the value of the car when you buy it, and the estimated value at the end of an agreed period (typically up to four years) in which you pay monthly instalments. Then, you can walk away, buy the car or trade it in. It’s smart never to take any finance deal offered by the car dealership without shopping around.

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