If a bank gives you money under the promise that you will pay them back in pre-arranged instalments, it’s called a loan. That promise can have two variants: the lender only takes your word as a guarantee that you will pay the money back or they may require you to use something to back up the loan, usually an asset. The first is called an unsecured loan and the latter is known as a secured loan.
A method used by banks in order to borrow money, the money is backed up by an asset. Having a secured loan is a promise that the lender will have ownership over the item if you fail to repay the loan. The most common assets used for this type of loan are houses and cars.
Sometimes the debt becomes greater than the asset that was originally used to back it up, meaning that after the bank takes ownership of the property/car, people can still have debt.
It works like this: Lenders sell the property or the asset and get the money back, but if what they get is less than the original loan amount, you’ll be accountable for the difference and would still be in debt.
The main difference here is that there´s no asset to back up the loan, this means that the lender has no rights over your property, even if you don’t repay. Student loans are a good example: when a student receives a loan, he/she does not require to give their rights over an asset to secure it.
Now, to access other forms of unsecured loans that are not student loans, your credit score will be crucial to determining whether you get approved or not. A good credit score is the best tool for the lender to determine that you are likely to pay back and it also helps you to show them your responsibility with repayments.
The loan amounts are usually small as the lender doesn’t want to compromise either since there’s nothing but your score to back the loan up.
How does credit reporting work with these type of loans?
Either secured/unsecured loans will be reported to the credit bureaus, this includes late payments and other minor details. In the event that you fail to pay and the bank seizes the property either by using foreclosure or repossession, this will also be reflected in the report.
It goes without saying that such entry in your credit score report has a big negative impact on you and the way banks perceive you.
Which one is better for me?
It may seem unreasonable that someone will choose a secured loan when there’s a risk of actually losing the property if repayments are not met. However, most of the times a secured loan is the only way for people to get approved for a loan.
People with low credit scores will have a difficult time getting approved – because it’s risky to lend them money – so they may be forced to go with a secured loan.
Now, sometimes when people apply for a secured loan, the loan amount can be increased substantially, but this can represent a major risk for people, as chances of actually losing the property increase significantly. People need to be aware of the risk entailed, plus they need to look carefully at interest rates, the amount of the monthly instalments and the repayment period.
What options do I have without compromising my assets?
Building a good credit history is the best tool you have. A steady income and good saving habits, plus always paying on time will get you there. Follow these practices and banks will start trusting in you.
Another way is to boost your savings/earnings, and since we’re talking about banks, it may be a good idea to see if you were a victim of the PPI scandal. You can use the money to boost your savings and look more appealing for an unsecured loan – or if you already have a secure/unsecured loan, you can use it to make a larger repayment. This will provide peace of mind and will reduce the amount of time you have to repay the loan.