A Guide to Unsecured Lending

Posted byDaniel Tannenbaum | Category Blog | Date 18 August 2016

An unsecured loans involves borrowing a few hundred or thousand pounds from a bank, lender or financial institution but you do not need to put down any assets as collateral (e.g car, home) to be eligible. This means that if you are unable to meet repayments, you do not risk your valuable property or items being repossessed by the bank or lender. Examples of unsecured loans include:

  • payday loans
  • home improvement loans
  • emergency loans
  • weddings
  • personal loans
  • peer to peer lending
  • credit cards

Source: Proper Finance

As the lender has no security if you default you loan, they tend to charge higher rates to account for this – hence unsecured lending can run in the thousands of per cent of APR for products like payday loans. Also, the loans tend to be shorter with some only lasting a few days, months or years.

How is an unsecured loan different to a secured loan?

A secured loan means that you are applying for finance that is secured on a valuable item such as car, home, watch, art or jewellery. The lender has added security that they will be able sell the item to recover the cost of the loan if the borrower is unable to repay.

unsecured-loans

Common examples of secured loans include mortgages, logbook loans and other car loans. As the lender has security, the interest rates charged for secured loans are typically lower and the amount the individual can borrow can be much higher and for longer. For a mortgage, which is probably the most common type of secured loan, an individual can borrower thousands or even millions for up to 45 years and pay mortgage rates of 1-5% per year.

Unsecured LoansRepresentative APRLoan AmountLoan Duration
Payday Loans1300%£50-£2,5002-4 weeks
Guarantor Loans39.9%-49.9%£500-£15,0001-7 years
Personal Loans3.30%£1,000-£50,0003-5 yearsSource: MoneyAdviceService
Credit Cards18.90%Depends on credit ratingAnnual
Secured LoansRepresentative APRLoan AmountLoan Duration
Mortgage1-5%Depends on affordability1-45 years
Logbook Loans253%£500-£50,0006 yearsSource: Quiddi
Car Finance19.50%£500-£50,00036 months

The rates depend on your credit rating and affordability

You may notice in the tables above how the rates vary between lenders for secured and unsecured products. This is because although putting down collateral is one aspect, your credit rating and affordability is key.

Those with good credit ratings are considered less risk to lend to and therefore a good credit score will boost your chances of being approved and give you access to the best rates and a higher amount that you can borrow. This is particularly the case for credit cards, peer to peer loans and mortgages.

rates-depending-on-credit-score

The other aspect is affordability which refers to your income and expenses and how you can afford to repay what you have borrowed. Most lenders will look at your income, salary, employment status and try get an idea of your monthly expenses and the amount you can borrow and the rate you are charged will depend heavily on this.

How can you get an unsecured loan with bad credit?

Since unsecured lenders have no collateral, they need to find alternate ways to provide loans to those with bad credit. This can be achieved in the following ways:

  • higher interest rates
  • lower borrowing amounts/credit limits
  • guarantor

In most circumstances, lenders will charge you a higher interest rate if you have bad credit to make up for the risk of bad debt. This is common for credit cards with bad credit where the cost of borrowing can be 0-6% compared to 24.7%-35.9% for customers with bad credit. (Source: MoneySavingExpert)

In terms of the amount you can borrow, your credit score is key to unlocking the maximum borrowing facility. Certainly with payday and peer to peer loans, the better your score, the more you can borrow. So if you have a poor credit history, the amount you can borrow may be limited to reflect the extra risk.

The guarantor loans we compare on our website are a bit of a hybrid of this. They are ideal for those with bad credit and by having a guarantor with a good credit history (ideally a homeowner), they are able to get the finance they need. So it is not quite a secured loan because there is nothing put down as collateral, but the lender does have added security by having a guarantor part of the application.

The criteria for unsecured loans

To be eligible for an unsecured loan is quite similar to a guarantor loan, other than needing a guarantor. Typically, applicants need to be over 18 years old, living in the UK, have a working debit account, in employment earning around £500 per month so that they can afford repayments and have a good credit score to improve their chances of being approved.

There is likely to be a different criteria depending on the loan product and the lender – and obviously different products and rates are available to those with good and bad credit scores.

The consequences if you cannot repay

As discussed, if you default on a secured loan like a car loan or mortgage, you risk your asset being repossessed by the lender so they recover the amount they have lent you. The lender will not take your car or home immediately as they will give you a little bit more time to repay by sending letters, follow up phone calls and even offering an arrangement to pay.

For an unsecured loan, the biggest impact of failing to repay will be on your credit score. As the information of whether you have repaid or not is sent in real-time to a credit reference agency, a defaulted payment may cause your credit score to fall. The implication of a worse credit score will make it harder to access mainstream finance in the future and you may not be able to get the best rates available.

In addition, borrowers that miss repayments can expect one-off default fees that range from £15 to £30 for every missed repayment. There is also daily interest that can be added on your loan for every day that you go without repaying on time e.g paying 7 days late can add 7 days worth of interest onto your loan.

Giving the consequences of missed repayment, it is important to think about how you are going to repay your loan before you apply. Whether it is through your own income, savings or inheritance, you need to avoid the possibility of falling behind on repayments and this can ultimately increase the cost of your loan and negatively impact your credit score.