An unsecured loan is risky for the lender as they are not securing the loan against any other asset. As a result, the interest rates charged on unsecured loans are considerably higher than those charged on secured loans such as mortgages and other forms of property finance.
Moreover, unsecured loans are not easy to obtain for those with a poor credit history. Both these factors are reasons why people continue to apply for secured loans, the most common type being mortgages. The fact that it is such a commonly used financial product makes it important to know how to utilise it in the best way possible.
Why should you use property as collateral for finance?
The following are some of the reasons why you may consider using property as collateral for finance:
Easy to secure
As we mentioned earlier, providers of unsecured loans do not secure the loan against an asset and therefore lending to a borrower is a high risk for them. In such cases, it is only natural that lenders would finance those individuals whom they find capable of repaying the loans.
As a consequence, people with poor credit scores who apply for unsecured loans are often turned down by the lenders. Secured loans such as a mortgage loan provide greater financial security for lenders as they can take control of the property if the borrower fails to repay the loan.
It is possible to borrow more
A mentioned above, the lack of security makes unsecured loans difficult to obtain. It is also the reason why lenders are not willing to lend very large sums of money to borrowers. On the other hand, providers of secured loans are more comfortable with handing out bigger loans.
Longer repayment schedules
As heavy set-up costs are involved in secured loans, lenders prefer the term of the loans to be longer – usually a minimum of five years, but going all the way up to 25 years and sometimes longer. On the other hand, unsecured loans are normally expected to be repaid within one to seven years.
In addition, the amount that you need to repay on a monthly basis is significantly lower with a secured loan as you are borrowing over a longer period of time. However, the amount of interest that you pay on the loan amount also increases when you take out a long term loan.
Advertisements on television that promote secured loans cannot be entirely trusted as lenders are quite unwilling to provide loans to those individuals who are heavily in debt, despite the fact that there is the ownership of a house at stake. Such loans are ideal for those who are looking to pay existing debts, but they are extremely risky for those who are considering taking a secured loan only for the sake of making new purchases or additional borrowing.
How to use your property as collateral in a safe and secure manner
The following are certain things that you must consider before putting your home equity at risk:
How much should you borrow?
Make a list of your existing debts on a piece of paper and determine the total amount that you owe. If you have contacted several loan providers, you may already have a good idea about the lowest interest rate that you can get.
In the sequence of debts that you owe, the money that you receive from the secured loan should be used ideally to pay off debts that are more expensive than the one that you are about to take out.
No matter how much a loan provider may force you to consider debt consolidation, do not go ahead with it if you do not 100% sure. The only thing that you need to remember is that the higher the interest rate or the longer the duration of the loan, the more expensive the loan will be for you.
Fixed rate debt gets converted into variable rate debt
Usually, in the case of unsecured loans, the rate of interest is fixed for the entire term of the loan. Secured loans are different from unsecured loans in this aspect as the rate of interest is variable and are likely to change as the UK base rate changes, and whenever the lender also changes their rates.
When you are thinking about converting a standard personal loan, which is a fixed rate debt, into a variable rate debt, you must ask yourself if you can afford the repayments if interest rates were to be increased. If you doubt your ability to do so, you mustn’t go ahead with the loan.
Some secured loan providers may offer you fixed rates, but they are usually for a short duration of time. Another important aspect of unsecured loans that you must be aware of is whether the provider can impose a penalty for early repayment of debt.
How long to borrow for?
Creating a budget will help you find the answer to this question. You must be able to determine the maximum amount that you are able to repay. If you underestimate your ability to repay, it may take you longer to pay off the debt resulting in you having to pay more interest.
However, if you overestimate your repayment ability, it may leave you struggling to make the repayments which could ultimately cost you your home. Since there is a house at stake, you are advised to plan very carefully before making a decision on what is affordable for you.
How much does it cost?
How much a loan against a property ultimately costs depends on several factors including the length of the loan, the size of your loan, the equity in your home and also your credit score.
It is possible that the same loan product may be cheaper for those with a good credit score but less home equity but more expensive for those with a poor credit score and high home equity.
Your outstanding debts and income determine your credit score, along with any failures to make any repayments in the past, history of bankruptcy, instances when your failure to repay were taken to the court or you went into arrears.
Before taking out a loan against a property, it is important to carefully review your situation and get in touch with an advisor to talk through all the options available to you.