Secured loans used to be a very popular way to borrow with incessant ads on daytime TV, but the market imploded during the financial crisis. As the financial system seized up, lenders in this industry found it hard to obtain the money to lend out.
However, the secured loans market has now started a modest recovery. The level of lending rose 22% in July to £32 million, according to Loan Warehouse’s Secured Loan Index. Although this is still a long way below lending levels during the boom, it’s a sizeable recovery.
I think that recovery raises two questions:
- Are secured loans a sensible way to borrow?
- And what exactly are they?
The simple definition of a secured loan is that’s a loan secured against an asset, normally property. So if you can’t repay the loan, the lender can then seize the asset and get its money back by selling the asset.
Obviously, a mortgage is secured against the borrower’s home, so, stricitly speaking, it’s a secured loan.
However, when you hear banks and journalists talk about secured loans, they normally don’t mean mortgages. Instead they mean smaller loans that are secured against residential property, normally in addition to a conventional mortgage.
So let’s say that you own a house that is currently worth £300,000 and your outstanding mortgage is £100,000. The difference between those two numbers is £200,000, so you have equity worth £200,000 in your home. You can take out a secured loan against that equity and that loan would normally be for a sum between £25,000 and £100,000.
If you hit financial trouble and you couldn’t repay your mortgage and secured loan, your mortgage lender would be first in line for any sale proceeds following a repossession. But once the mortgage lender had been paid off, your secured loan provider would be next to receive payment from the sale proceeds.
Secured loans are also sometimes known as homeowner loans or second charge mortgages.
Fans of secured loans point to three main plus points for these products:
1. You don’t need a perfect credit rating
If your credit rating is less than perfect, you may struggle to borrow via other routes such as a personal loan.
But because a secured loan is backed by property, the lender may be willing to look at riskier borrowers.
That said, your credit rating is still relevant when you apply for a secured loan. The worse your credit rating, the higher your interest rate. And if your credit rating is very poor, you may not be able to get a secured loan at all.
2. Rates can be relatively low
Interest rates for secured loans can be relatively low. Right now, the cheapest secured loans are at around the 8.5% mark. Rates are certainly a lot cheaper than for payday or guarantor loans.
3. Long repayment periods
Secured loans can last for ten years or longer. So that gives you plenty of time to pay off the debt. On the downside though, the longer you take to pay off the loan, the more interest you’ll have to pay.
However, I think that secured loans have some major flaws that outweigh the advantages.
1. You could lose your home
This is the big one. If you miss payments on your loan, you could end up losing your home.
For that reason I’d always advise people to go for an unsecured personal loan if they can. It’s true that a lender could still repossess your home if you fall behind on a personal loan, but the process is much more complicated than for a secured loan and happens much less frequently.
2. The temptation to party
Secured loans are often marketed as a solution to a big debt problem. If you’ve got too many debts, you could take out a secured loan, pay off all your existing debts and then benefit from a relatively low interest rate on your secured loan. TV ads often refer to ‘consolidation loans'.
Consolidating all your loans into a secured loan might be a good solution, but there’s a big danger. Instead of paying off all your existing debts, you may be tempted to spend some cash and have fun. That’s only going to make your debt situation worse in the long-run.
If you’re struggling with debts, I’d urge you to speak to one of the free debt advice charities: National Debtline, the Consumer Credit Counselling Service, or Citizens Advice. They can help you cut your spending and possibly help you negotiate lower interest rates or a longer repayment schedule with your creditors.
3. Secured loans normally have variable rates
Secured loans normally have variable rates while personal loans normally have fixed rates. Variable rates are obviously riskier as you could be caught out if interest rates jumped in a few years’ time.
So what are the alternatives?
0% credit card
If your debts are on a credit card, you may be able to transfer them to a 0% balance transfer card and not pay any interest. Way better than a loan!
Personal loans tend to be cheaper and the risk of losing your home is much lower.
You may be able to borrow extra cash on your existing mortgage – either by remortgaging or by asking for a ‘further advance'. Either option should be cheaper than a secured loan although you are still increasing the risk of losing your home.
My view is that the risk of losing your home, and the temptation to carry on spending are very serious flaws. Unless you’re very disciplined and confident you can make all your repayments, steer clear of secured loans.