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What is a Secured Loan?
Secured loans allow you to borrow lump sums of money, which are secured against a privately owned property such as a house, car or any other valuable item.
The amount received from the lender can be used for any purpose, however, they are most frequently used by homeowners or mortgage payers who require a large amount (above £25,000) for home improvements, large material purchases or alternatively the consolidation of existing debts. In order to qualify for a secured loan with a property as security, this property must be able to be sold.
How do Secured Loans work?
When applying for a secured loan, you will need to fill in a credit agreement as well as provide proof of income, proof of affordability, proof of identity and proof of any mortgage you might have out.
The amount of money that lenders agree to lend depends on the ability of the borrower to repay the loan, that assessment is based on the personal and financial circumstances of the borrower, personal salary or pensions and credit history.
The second factor taken into account is the Loan to Value (LTV) or so called equity, calculated from the outstanding amount of your mortgage as a percentage on the value of your home.
Depending on whether you already have a mortgage on your property, a distinction is made between first and second charge, giving the first charge priority over the second.
If there are no mortgages secured against your property, the lender of the secure loan holds the first charge.
Not all secured loan providers deal with their clients directly, so in some cases this might require you to use a secured loan broker. They deal with the lender and help to sort out the paperwork.
Brokers usually charge fees such as a legal fee and valuation fees, which are added to the amount of the loan and repaid along with the interest.
Throughout the term of the loan, regular monthly payments must be made that are subject to the terms and conditions of the agreement and depend on the annual percentage rate (APR) that you are charged. Secured loans usually have repayment times between five to 25 years. Lenders normally take a variable interest rate and monthly repayments tend to be lower than those for unsecured loans.
Different types of Secured Loans
- Homeowner Loan: This type of loan is frequently taken by people who are not eligible for other types of loans, for example due to a bad credit history. This is due to the fact that the higher risk of late or non-payment taken by the lender is covered by the loan being secured by a property.
Like with other secured loans, the amount that can be borrowed with a homeowner loan depends on the equity, the present value of the property minus the outstanding mortgage. In exceptional cases, lenders can agree to lend 125% of equity, but they will request a higher interest rate in exchange.
- Title Loan: In the case of a title loan, the lender becomes the legal owner of the property, such as a house or car, until the loan is fully repaid. If the loan is not repaid in time, the lender is entitled to repossess the property.
- Secured Car Loan: This is a loan specifically designed for the purpose of buying a car. By taking out a loan against a new car, this car can only be resold once the loan has been fully paid.
- Consolidation Loan: This loan is taken out for the purpose of debt-consolidation, when you should decide to consolidate different types of debts from credit and debit cards and unsecured loans into a single secured loan, which can then be repaid over a longer period of time.
People tend to choose this type of loan, as the interest rate offered is usually lower than those charged by the different card providers, but again the rate is determined by personal and financial circumstances.
Before making the decision to take a consolidation loan, you should find out whether you are exchanging a fixed rate loan for a variable rate one and whether this has a negative effect on the overall sum to be paid.
Paying monthly over an extended amount of time reduces the rate of the monthly payments, but due to the delay and interest it can drastically increase the overall amount to be paid back.
Possible Drawbacks of Secured Loans
Applicants for secured loans should be aware that, should they miss a monthly payment, they will be charged a missed payment fee and the account falls into arrears. It will be reported to the lender and in some cases may influence your credit history.
In case of default, the lender has a right to start a court order and request the repossession of your property in order to retrieve the money. If the property is sold, the first charge lender is ranked first and thus will be paid first, while the second charge lender receives what is left until the outstanding debt is fully covered.
For the borrower, this agreement entails the risk of losing the own house or property, a fact that should always be kept in mind when applying for a secured loan.
Moreover, secured loan interest is usually variable and hence difficult to make a budget plan in advance. In the case of borrowers holding a mortgage with variable rates, they run the risk of being hit twice should the rates go up.
Finally, debt consolidation is often considered a last resort for homeowners and only provides a short term solution to financial straits.
Choosing the right Secured Loan
When looking for a secured loan, you should draw your main attention at the interest rate that you are being charged. The lower the interest rate, the less you should repay.
While most secured loans offer variable interest rates, you should look for a fixed interest rate, as it makes it easier to plan your budget you will not be hit by a sudden increase of interest.
If you are seeking to repay your loan early, you should moreover pay attention, whether your lender charges early repayment fees.