What You Should Know Before Taking Out a Secured Loan
With interest rates rising and the overall cost of borrowing going up, it might feel like your options for taking out a loan are fading by the day. Since daily financial needs never take a pause, there is a chance that some might consider taking on riskier forms of credit like secured loans to bridge the gap.
Secured loans may sound like the perfect option, especially because lenders love to advertise affordable monthly payments and accessibility, but like many other kinds of credit, there are more risks than meets the eye.
Before you jump on board with a secured line of credit, make sure you understand the details and risks involved.
What is a Secured Loan?
If you default on your secured loan and fail to make timely repayments, the lender can seize the collateral (which is sometimes referred to as ‘security’) to recover their losses. Secured lines of credit are safer for lenders because they have something to fall back on in the event you stop making payments.
Benefits of a Secured Line of Credit
Secured loans are a highly accessible way to borrow money for those that have an asset worth money such as a house. Let’s take a look at some of their benefits:
- Low interest rates: Interest rates averaging between 3 and 6% are some of the lowest for any type of credit.
- Accessible to individuals without excellent credit: Because the loan is secured with your home (or another asset) as collateral, lenders are typically less concerned with your credit score.
- Can help build your credit score: Secured lines of credit can be good credit building tools; their affordable monthly payments can benefit your credit history while also diversifying your credit mix when managed properly.
Risks of a Secured Line of Credit
Secured lines of credit have great benefits, but their risks might outweigh them. Understanding these risks is critical for making the best decision for your finances.
- Often come with a variable interest rate: While interest rates for secured lines of credit are typically low, they’re often also variable interest rates. This means that if interest rates go up like they have in the UK in recent months, your monthly payments could change significantly.
- Longer payment terms means more interest accrues: While long payment terms can benefit you by making monthly payments more manageable, it can also hurt you. Interest has more time to grow when payments are spread over such a long period.
- Your home is on the line: Making all the necessary payments and ensuring that you’re prepared for changes in interest rates is absolutely essential when it comes to secured lines of credit. If you fail to make the payments, you could lose your home.
Is Getting a Secured Loan a Good Idea?
Secured lines of credit can end with you paying back much more than you initially borrowed. In most cases, it’s best to avoid using a secured line of credit for anything that won’t raise your collateral’s value.
For example, if you’re repairing your home’s roof, a secured line of credit might be good, as it allows you to borrow much more than a personal loan might, and the repairs increase the value of your home.
However, using a secured line of credit for debt consolidation or any other circumstance where a personal loan would suffice can lead to risks like long-term debt and the potential for losing your home.
What is an Unsecured Line of Credit?
An unsecured line of credit refers to any line of credit not backed by collateral. Compared to secured lines of credit, unsecured lines of credit typically have higher interest rates and stricter affordability tests, as they’re more risky for lenders to take on.
For example, if you fail to make your repayments on a credit card—which is a type of unsecured credit—the lender can’t repossess your home or anything to recover their losses.
The lender will report those missed payments to the UK’s credit reference agencies, who may lower your credit score as a result. Additionally, a lender could take you to court over the debts if you fail to pay them, which could result in a CCJ being placed on your credit file, damaging your ability to get credit.
Secured Line of Credit FAQs
Here, we answer a few additional questions about secured loans so you’re as prepared as possible before you make any decisions.
Can You Lose Your House With a Secured Loan?
Yes. If your house is your collateral on a secured line of credit, a lender could repossess it if you default on your payments. However, most lenders don’t want to take your home, and doing so creates a lot of work for them. If you do have a secured line of credit and can’t make your repayments, contact your lender to see if an alternative payment schedule can be worked out.
What is a Logbook Loan?
A logbook loan is a secured line of credit that uses your vehicle as collateral. Logbook loans are an expensive way to borrow money, with average interest rates hovering around 400% according to the FCA. That’s less expensive than the 4000% interest rates payday loans are known for, but leaps and bounds more costly than personal loans.
Can I Repay a Secured Loan Early?
One final disadvantage of secured loans is that they have little room for flexibility when it comes to making early payments. Unlike most other personal loans, which you can make early payments on as you please, secured loans typically have a fee associated with early payments.
Secured Loans Can Be Risky; Know Your Options
A secured loan can be an easy way to get a credit line if you have poor credit. However, they come with significant risks, and personal loans may be more suitable in many cases. However, if your credit score doesn’t meet a lender’s eligibility requirements, you may feel like a secured loan is your only option. Fortunately, Pave is here to help you build your credit score.
To be eligible for the best credit products, stop taking on risky forms of debt and start building credit the right way. To see for yourself why hundreds of thousands of people across the UK have turned to Pave for help building their credit, download Pave from the App Store or Google Play today.