In line with our risk management framework, today we published our Q4 2019 performance update.
Are personal loans better than secured loans?
The concept of lending and borrowing dates as far back as biblical times, although it was the early Italian pioneers who transformed this into the more fluid, quantifiable exchange we can associate with today whereby they would set up benches in busy marketplaces to provide a central point for people to borrow money. These benches were known as ‘bancas’, from which the word ‘bank’ is derived.
The problem with such transactions was that there was no central authority to regulate them, and interest rates were heavily varied - and borrowers were thus subject to exploitation. That’s not to say the illusion of a perfect system has been reached in the centuries since, and the recent financial crisis was (and still is) a traumatic reminder of the risks involved with any credit model.
The decline of interest rates
Nevertheless, today the climate for borrowing money in the UK has become quite favourable for those with decent credit ratings, which is largely to do with the fact that interest rates across the board have plummeted since 2008. Natural economic factors and a lack of consumer confidence as a consequence of the downturn were the root causes of this decline. However, as banks and building societies pulled up the drawbridge in terms of lending to consumers, HM Treasury launched its Funding for Lending Scheme (FLS) in July 2012 (it was removed in 2014) offering them billions of pounds in loans at rates as low as 0.25 per cent. The condition of this was that they then lent this money out.
The FLS thus applied significant downward pressure on the rates of both secured and unsecured loans in this country. Fixed-rate mortgages on average tumbled by 1 per cent over an 18-month period, while personal loans – previously available at best rates of around 7.5 per cent – are now attainable at interest rates of less than 5 per cent in some cases.
The continued downwards pressure on personal loan interest rates have been assisted by increased competition and the growth of online platforms, which have changed the dynamics of a market previously dominated by the high-street behemoths. The result of this is that in certain cases, rates on personal loans have even dipped below corresponding rates on secured loans.
This, in many ways, defies logic. Secured loans are asset-backed (usually against the borrower’s property), thus significantly reducing the risk of loss to the lender. For an unsecured lender, there is no such security against the loan so, to compensate for taking additional risk, the economic assumption is that they must charge a higher rate of interest. But clearly, this isn’t always the case.
What are the cheapest amounts to borrow?
An important thing to note is that any examples of cheaper rates on personal loans are likely to be for amounts between £7,500 and £15,000, as there tends to be more competition within the market for loans of that size.
Interestingly, smaller personal loans often result in higher rates. This is partly due to the fact that the majority of defaults and bad debts arise from those who borrow smaller amounts of money. However, the more significant factor is that for larger lenders, who have high per-loan administrative and underwriting costs, smaller loans are not worth their while, and they thus generally look to deter consumers from borrowing at these levels.
This of course creates a niche for smaller, more-nimble online peer-to-peer lenders like ourselves who have lower overheads and are thus able to fill the void.
So are unsecured loans the more preferable option?
It’s a broad question with no straightforward answer, but the virtues of personal loans for borrowers are plain for all to see. Aside from not being obliged to secure the loan against your home, application processes, particularly with agile online platforms such as ours, tend to be convenient and expedient. Additionally, a select group of unsecured lenders, including ourselves, will not charge for overpayments and early settlements. Given that most financial services firms (and all secured lenders) have interest charges of up to 55 days extra for paying loans off early, this presents a key potential saving for a loan seeker.
However, there is an important limitation on unsecured loans in that you can only borrow an amount ranging from £1,000 to £25,000, so for those looking to borrow more, a secured loan is likely to be the better option. Furthermore, those with credit ratings slightly below prime might be more likely to be approved for a secured loan (and at a better rate) given that the risk to the lender should be lower. And of course, despite recent trends, APRs on secured loans will usually still be lower too.
All in all, it is a personal choice which comes down to individual circumstances. What is important is to have a clear understanding of the pros and cons with each, and then discuss the terms with the lender so that you end up with a loan arrangement that works best for you.
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