You may well already be familiar with the difference between secured and unsecured loans. Secured loans require some form of collateral against which money can be borrowed; unsecured loans are an agreement where the terms of repayment are based on your credit score or history with the lender.
Although the two types of financing are typically compared in black and white terms, with one summed up as the opposite of the other, there are more nuances in the difference between the two than you might be aware. Particularly as the credit market evolves, diversifies and recovers from the 2007-2008 crisis, new opportunities and risks have emerged.
Traditionally, secured loans would be used for larger purchases or investments and unsecured loans for a smaller, perhaps unexpected need for cash. This was possibly because the most common form of collateral used in secured lending was real estate; its high value necessitating it only be used when the level of investment involved demanded it.
A new selection of personal asset lenders has changed this picture. Thanks to companies like Pawntique, Pawn Up and the UK-based Borro it’s now possible to take out smaller collateral loans from around $1000, borrowed against less valuable, more easily liquidated assets. Deluxe watches, jewelry, precious metals, even art, antiques and wine can be used as collateral.
One advantage of an unsecured loan was a more flexible repayment schedule. If new funds became available e.g. a late invoice was paid, it was possible to pay the loan off early. Secured loans often had a fixed, long-term repayment schedule with penalties for early settlements or restrictions on overpayments.
This is an area where the landscape has changed, with personal asset loans available that can be repaid in full at any time. The increased flexibility also extends to the length of repayment, which can be as short as a month. This makes secured loans a far more attractive choice for short term funding than they previously were.
One of the biggest hurdles in taking out a secured loan was the fear of losing your home. As mentioned earlier, you can now take out loans against a far greater variety of assets. Though it may still involve a risk and certainly no-one wants to be parted from their hard earned car, watch or antique candelabra. It’s a far more attractive proposition than using your home as collateral.
In terms of assets, another advantage these new types of lender have over traditional banks is a greater expertise in appraising your assets. Banks, as well being notoriously cautious when valuing your property, also do not specialize in appraisal. Companies with decades of experience and in-house teams dedicated to assessing value now exist to ensure you’re not short-changed when handing over your assets.
Depending on your local law, if you have an unsecured loan you cannot pay back, creditors can apply for a charging order. This means money borrowed through unsecured means can be regained from an LLC.
So although an unsecured loan may appear to have few risks other than potential damage to your credit score through missed or late payments, in fact, in certain cases it can leave you open to action which puts other savings or assets at risk. These tend to be rare occurrences but are something to keep in mind when weighing up the use of collateral.
If you do have a good credit score and are looking for a short term cash flow fix, or small loan, then unsecured loans as well as credit cards or overdrafts are still attractive options. They also may give you the opportunity to negotiate or shop around for better rates, unlike asset lending, which is based purely on the value of your property.
Cheap unsecured loans have become harder to come by over the last five years, but using them instead of asset lending does allow you to build and improve your credit history, making future lending easier. The difficulty in finding them perhaps explains just why so many new and flexible methods of secure lending have emerged: a reaction to the changing credit market and the needs of individuals and small businesses.