Secured vs unsecured personal loans: Which is right for you?

If you’re looking at getting a personal loan, you’ll have to decide whether to go for one that’s secured or unsecured.

Both types of personal loans have their benefits and flaws, and one may be better depending on your circumstances.

So what’s the difference and how do you choose which is right for you?

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What is a secured personal loan?

A secured personal loan is a loan secured against something you own, like a home, car, or boat. The lender uses this asset as security, also known as collateral, which acts as protection for them in the event you can no longer repay the loan. In this event, the lender would seize the asset and sell it to recover money still owed to them.

Given the security you’re providing to the lender, secured personal loans often have lower interest rates than their unsecured counterparts. However, there is often a longer approval process to ensure the security is appropriate for the amount being borrowed.

Secured personal loans typically allow you to borrow more money than an unsecured loan. Keep in mind though, just because you’re offering up a $40,000 car as security, for example, doesn’t mean you’ll automatically be able to get a $40,000 loan.

Different lenders will allow you to use different assets as security for a secured personal loan. Typically though, assets you may be able to use include:

• Property: You can use a property you own, be it residential, commercial, or investment as security. Should you have a home loan with equity in it, you can also use this as security. Land can also be used as security.

• Vehicles: New and used cars, motorbikes, and boats can all be used as security.

• Cash: Just like you would with a home or car loan, you can put down a cash deposit and the lender will accept this as security for a loan. Some will also allow you to use the cash in a term deposit as security.

• High-value assets: Some lenders will allow you to use expensive jewellery and art as security. This is obviously judged on a case-by-case basis.

What is an unsecured personal loan?

An unsecured personal loan is a loan that has no security attached to it. Instead, the lender will review your finances, your income, and your expenses to decide whether you will be able to make repayments on the loan. Due to there being no security, interest rates on unsecured personal loans are typically higher than secured loans as they’re higher risk. You also won’t be able to borrow as much money as you would with a secured loan. However, approval is typically quicker, and there is greater flexibility in what you can do with the borrowed funds.

Although there is no security on the loan, if the borrower can no longer make repayments, the lender will still take action to recover the funds.

How to choose between secured and unsecured

If you’re unsure of whether to go with a secured or unsecured personal loan, these are the main factors you should consider:

Interest rate

Whether you go unsecured or secured, the interest rate is one of the most important things to consider when borrowing from a lender. Prior to borrowing, you need to ensure you’re in a position where you can afford whatever the monthly repayments will be.

A secured loan will allow you to take advantage of a lower interest rate than an unsecured loan, which will result in lower monthly repayments. However, should you not be able to make repayments, the lender may take the security you provided them and sell it to cover the remaining balance of the loan.

An unsecured loan sees you avoid this risk, but you’ll be subject to a higher interest rate as a result, so higher repayments. Should you not be able to make repayments the lender will still find a way to recover the funds owed to them.

How you can use the funds

Secured loans typically come with stringent conditions for what you can use the borrowed funds for. For example, if you wanted to buy a car and you used your house as security, the lender may require you to give them all of the details of the car you wish to purchase. Some lenders won’t let you buy a car that’s older than five years. Lenders also typically let you use funds from a secured loan for multiple items.

An unsecured loan allows you to use the funds at your discretion and for multiple purchases, with few if any restrictions on the purchases themselves. For example, if you took out a $30,000 loan for a ten-year-old $15,000 car, and wanted to use the remaining funds for a holiday, an unsecured loan would allow you to do this.

Fixed or variable

Depending on what you want to use the funds for, either a fixed or variable rate loan may work better. For example, if you want to buy a car, it may be better to get a fixed secured loan, as you can use the car as security and there is a larger market for fixed loans in this space.

If you’re looking to pay off the loan quickly and make extra repayments, a variable loan may be the way to go. Fixed loans typically have fees for extra repayments and heavy penalties for paying off the loan early, whereas variable loans often allow extra repayments at no extra cost and no penalty for paying off the loan early.

Loan amount

If you’re looking to borrow a large amount of money, over $100,000 for example, a secured loan may be the way to go. Given the amount of money being borrowed, the lender requires you to provide security. You typically can’t borrow more than $100,000 with an unsecured loan.

Fees

There is typically not a great deal of difference between unsecured loans and secured loans in the fees you pay. Establishment fees are charged by many lenders but not all, and the same applies to monthly fees.

Loan term

As with fees, there is typically no difference in the loan terms for unsecured and secured loan terms. Fixed loans range from one to five years, while variable loans can go as high as seven years.

Gift items

If you’re taking out the loan to purchase an expensive gift for somebody (e.g jewellery), you might not want to secure the loan to that gift given that the recipient could lose the gift in the event you fail to meet your repayments, which could be very embarrassing.

Who offers secured and unsecured personal loans?

You’ll find many banks in Australia that offer home loans also offer personal loans. Each of Australia’s big four banks - ANZ, Commonwealth Bank, NAB, and Westpac - offer personal loans. There are also a large number of smaller businesses that are set up to specifically offer personal loans. Beware of specialist lenders that charge higher than average interest rates in exchange for requiring less information on your application or ignoring a bad credit rating. It’s worth doing your research to find the right lender with the lowest interest rate for you.

Pros and cons of secured personal loans

Pros:

• Often lower interest rates

• Higher amount loans available

• Allows you to use your assets as security

Cons:

• Risk your security being seized by the lender if you can’t repay the loan

• Less flexibility over how the borrowed funds are used

Pros and cons of unsecured personal loans

Pros:

• Lessens the risk of a particular asset being seized

• More flexibility over how the borrowed funds are used

Cons:

• Often higher interest rates

• Generally can’t be used for loans of over $100,000

• Difficult to obtain if you have a poor credit history

Savings.com.au’s two cents

Picking an unsecured or secured loan comes down to your financial position and what you wish to use the funds for.

If you’re purchasing something like a car that’s less than five years old, a secured car loan may be the way to go, to take advantage of the lower interest rate.

An unsecured personal loan may be better if you wish to borrow a smaller sum for multiple uses.

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