Why Are Secured Loans Cheaper Than Other Forms of Personal Debt?
As UK consumers we borrow money for a myriad of reasons. Some borrow money to extend a home, others to buy a car, and some even borrow to finance a once-in-a-lifetime holiday.
These are some of the positive scenarios but not all money is borrowed to fund enjoyable experiences or upgrades to our material possessions. Sometimes money is borrowed to cover a loss of earnings, such as after a redundancy. Other times debt is accumulated to pay private medical bills where the NHS was unable to provide fast treatment.
The common theme between all of these different reasons for acquiring debt, is we want the loan to be as cheap as possible to repay.
When we say ‘cheap’, we’re not referring to the monthly repayment. The monthly repayment on loan A can be lower than loan B, but due to a longer repayment period, may end up costing more overall. The best way to compare how expensive loans are is to look at the total value in pounds that you will pay back over their lifetime. This will always be quoted in the documentation you will be given as you apply for a loan.
Shopping around for brands and loan types
When seeking a loan from the cheapest source, we will naturally compare the rates offered by different lenders to see which firm is offering the lowest interest rate and total repayment.
Different lending firms have a different cost base, a different pricing strategy and a different level of desire to win your business. Therefore, shopping around will usually result in you locating a cheap loan than just asking your local bank.
However, before you do this, you should revisit the question of what type of loan you need in the first place.
It’s the type of loan you take out that will have the biggest impact on what interest rate you will pay.
What different types of loans are there?
A review of the UK loan market reveals that there are broadly 6 categories of loan:
- Loans secured against residential property (mortgages)
- Loans secured against other assets including vehicles (secured loans)
- Unsecured, short term loans provided by your banking provider (overdraft)
- Credit provided to fund individual purchases up to a limit (credit cards)
- Unsecured cash loans that are disbursed same-day as an application (payday loans/ cash loans)
Mortgages are only applicable for home purchases. Short-term payday loans carry high-interest rates (such as 50%) which makes them unsuitable for all but desperate borrowers.
This leaves 3 categories available to the average borrower: other secured loans, overdrafts and credit card debt.
Why are secured loans the cheapest?
Secured loans typically carry the lowest interest rate of these types of loans because, with a secured loan, you provide an alternative method for the lender to collect on their debt if you cannot keep up with repayments.
You may use a car, part of your house or even valuable jewellery as collateral on the loan. This provides the bank with a higher level of assurance that they will see their return. This allows them to reduce the element within their interest rate which is designed to protect them from defaults and credit losses.
This saving is passed onto you, the borrower, in the form of a lower interest rate.