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loans 

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Last updated 10/22/2008

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Pitfalls of secured loans

A ‘secured’ loan may sound comforting and safe, but they can be anything but.

This is because with secured loans the lender takes a charge against your property, so if you default on repayments, it can repossess your home and sell it to recoup its costs.

In theory, a charge may be taken against any kind of asset, but it is usual for it to be taken against your home.

There are two types of secured loan:

  • where the lender takes a first charge on your property
  • if there is an existing mortgage on your property, the lender takes a second charge on your home, behind the primary mortgage lender.                   

Secured loans can be used to finance expenditure on consumer goods and services (such as cars and holidays), to top up an existing mortgage or to consolidate existing debt.

It is important that you do not confuse secured loans with unsecured loans. The crucial difference is that unsecured personal loans are not secured against your home.

With a secured loan, there is always the possibility that the lender could repossess your home if you fail to makes payments.  Many home repossessions are the result of individuals defaulting on secured loans or ‘second charge’ loans which they have taken out using their homes as collateral.

Consolidation loans

Existing debt can be ‘consolidated’ into a single secured loan, repayable over an extended period. The interest rate may lower than the cost of credit and store card debt, but more expensive than an unsecured loan.

Consolidated loans are more transparent and easier to manage than a slew of loans from lots of different lenders because you have only one lender to deal with. However, your home is at risk if you fail to make payments on time and these loans are rarely the answer to serious debt problems.

Homeowner  unsecured loans

These are often taken out by borrowers who have difficulty raising an unsecured loan because of an impaired credit history due to mortgage arrears, county court judgments and so on.

The loan limit is usually based on the surplus equity in your property (the value of your home, less your mortgage). The advantage to the borrower is that capital repayments can be spread over an extended period, thereby easing the cost of repayments.

The pitfalls are:

  • the rate of interest rate is higher than for a conventional mortgage and possibly unsecured loans because the loan is riskier to the lender who only has a second charge on your home;
  • the total interest paid over the term of the loan can be much higher than on a shorter-term unsecured loan.
  • the debt may persist well beyond the life of the goods purchased (such as a car);
  • there may be penalties for early redemption;
  • there are likely to be upfront costs like valuation and arrangement fees;
  • if the loan is being used to consolidate existing debts and has reduced the cost of your overall monthly outgoings, this could encourage you to take on further debt.

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