When a secured loan is the right thing to do

With personal debt at such a high level of a £1.3 trillion and the credit crunch starting to bit, it's expected that many of us may have to re-finance our debts into a secured loan to cut our monthly outgoings. But with such a wide choice of credit available including 0% credit card, why do some people choose riskier secured loans?

It's quite simple. Many people opt for a secured loan because they can borrow more than is possible from an unsecured loan and the loan can be taken out over a longer term. Unsecured loans are normally available up to £25,000 over six months to seven years whereas secured loans can be up to £100,000 over 25 years.

Borrowers often get a secured loan to consolidate debt into one loan, especially if they have been bashing the plastic, and very often the monthly repayment can be cut in half (although you are replacing short term debt with long term debt and may end up paying more interest).

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On the other hand, people dont just take out secured loans because they have taken on too much debt. Sometimes, its because they need a loan for major expenditure, perhaps for home improvements. Rather than extending their existing mortgage, they go for a separate secured loan perhaps because it may work out cheaper than their mortgage because they can pay it off over a shorter term say over 10 years. Or they might have a fixed rate mortgage than cannot be extended.

Robert Sinclair, director of Association of Finance Brokers (the trade body for secured loan brokers), explained that people take secured loans for many reasons: sometimes to consolidate debt or because they are income poor and equity rich and reducing monthly outgoings with a secured loan can improve cash flow.

He added that the one thing you should never do "is take out a secured loan to reduce your outgoings and then start building up debt on credit cards again".

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What are the risks with a secured loan?

Sometimes call a homeowner loan, a secured loan is called 'secured' because the lender secures the loan on the value of your home. The amount you can borrow is based on the equity you have in your home. As they have the security of your home, lenders are willing to lend more and over longer periods than unsecured loans.

The risk of taking out a secured loan is that if you can't meet the repayments you could lose your home.

Taking out a secured loan may reduce your monthly debt repayment but remember you are paying more interest. For example, a £10,000 loan at 8% over five years in total would cost £2,165.60 in interest, whereas over 20 years it would cost more than £10,000.

The other disadvantage is, like many mortgages, if you want to repay before the end of the term, there will be penalty fees to pay.

While a lot cheaper than credit cards now around 15.9%, secured loans can be slightly higher than mortgages. They currently start from around 6.3% and the interest rate is usually variable.

27 September 2007 © Moneyextra.com

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