Many individuals suffer with bad credit or credit problems. A mistake made by the majority is to assume that securing a personal loan will either be impossible or very expensive.
If you have poor credit and are looking for financing, a secured loan may be the best option for you. Depending on the amount of finance you need, it may be your only option.
Seeking a secured loan with a bad credit score is often the best way to help lock in the most preferred interest rates. Regular bank loans will often charge a high interest rate in order to cover their risk, but a secured loan works differently and can be less expensive.
How does it work?
A loan is considered secured when the borrower offers something to the lender to guarantee repayment of the loan. In most cases, the borrower’s owned property is used as security. Should the borrower default on repaying the loan, the lender then has the right to repossess the property in order to recoup the outstanding balance of the borrower’s loan.
Since the property is being used as security on the loan, lenders see these transactions as less of a risk, meaning lower interest rates for the borrower.
How Do I Know If I Am Eligible?
Homeowners and mortgage holders are eligible. Tenants are not.
Enough equity has to be held too. Home equity is the amount owned between the borrower and lender.
For example: a property worth £100,000 with £25,000 still to be repaid to the lender leaves £75,000 of equity belonging to the mortgage holder. Unless there are already existing loans secured against the property.
In the event of default, if a lender needs to repossess, they get paid first from the proceeds of the property sale because they initially provided the financing to buy it. They provide a first charge mortgage. A secured loan is a second charge mortgage. In the event of repossession, the mortgage lender is paid first and then the lender of the secured loan.
To use the above example again: a property worth £100,000 with £75,000 still to be repaid to the lender leaves £25,000 of equity belonging to the mortgage holder. It would not be eligible for a £50,000 secured loan as there would not be enough equity to cover both lenders in the event of payment default.
Lenders are more willing to accept people with a higher equity in their home than they are asking to borrow. With enough home equity, a secured loan can be provided even without a credit check being run. If a poor credit report is causing applications to fail – money talks!
What Can Be Used as Security Aside from Property for a Secured Loan?
Traditionally, lenders will only accept owned assets as security. For a secured loan for a large amount, lenders will want the loan secured against the property as it’s the highest valuable asset in most people’s financial portfolio. The reason for homes being preferred for security is that lenders are able to repossess the property and easily recoup any losses they may suffer from the borrower defaulting on the loan.
Since a home is the most common means of security, it is important to evaluate the risk associated with taking out the loan against the need for financing.
Various Other Types of Secured Loans
These are high value loans used to cover all types of home loans, including mortgages, remortgaging, and equity release. They are only applicable to home owners or mortgage holders.
The term home owner in finance means the person who owns the property outright. There will be no mortgage in place. A home owner has 100% equity in the property. Unless the title deeds are Joint Ownership, then each person has equal equity.
The title deeds to a home remain with the mortgage provider until the finance is paid in full. Once a mortgage is paid in full, title deeds are returned to the owner of the property, or their acting solicitor.
Tenants are not eligible for loans secured against a home because they do not own the asset.
While this type of secured loan relates directly to property, it is possible for a personal loan to be secured against a property regardless the reason for finance. All loan providers should make the terms of the loan clear before agreement about whether the terms of financing are secured against an asset or not.
The most popular type of vehicle loan is Hire Purchase. The buyer pays around 10% of the purchase price to hire the car with an option to buy at the end of the repayment contract. The rest of the finance is handled by the car dealership or a broker. The lender retains ownership of the vehicle. If the buyer falls behind on the agreed payment plan, the lender can repossess the car.
With a Hire Purchase agreement for a vehicle, the buyer will not own it until the last payment is paid. Until then, the vehicle can be repossessed at any time. The only exception to this is in Scotland, where buyers who have paid more than one third of the contract value, have some legal rights.
In Scotland, when one third of the contract value has been paid, the lender must take legal action before repossessing. Everywhere else in the UK, vehicle loans secured through Hire Purchase can be repossessed if payments fall behind. The car is the security for this type of loan.
This is another type of vehicle finance. It is only applicable to vehicle owners. This type of secured loan cannot be used to buy a new car. It is based on the value of a vehicle the person has full ownership of, meaning there is no financing associated with the vehicle.
For ease of access, logbook loans are the simplest of all bad credit secured loans. Most logbook lenders will not require a credit check and provide a fast turnaround.
The downside is that because of the simplicity, the costs are far higher. It is not uncommon for logbook loan interest rates to exceed 100% APR (Annual Percentage Rate).
Savings Secured Loans
Savings secured loans vary by provider. Some will lend to the maximum value of savings held in a savings account or notice account. Others will lend a set amount above the total savings held, such as allowing borrowing up to 3x the value of total savings held.
The loan will be secured against savings to the amount outstanding on the loan and there’s likely to be a withdrawal policy attached to your savings account, ensuring the money secured against the savings remains with the lender until the loan is repaid.
How Much Can be borrowed with a Homeowner Loan with a Bad Credit Rating?
It is important for borrowers to assess how much financing they need and what purpose the funds will be used for before applying for a loan. It is in their best interest to only borrow the minimum amount needed to help control the interest rates overall.
If the funds are being used to begin paying off other existing debt, it may be wise to add extra funding for contingency purposes to help compare monthly payments with different lenders depending on the amount of financing they are willing to extend.
Since the borrower’s property is being used to secure the loan, it is likely that the lender will only extend financing less than or equal to the amount of equity available in the home, since that is the portion of the home that the borrower owns outright.
Borrowers can determine the amount of equity in their property by comparing the value of the property against the outstanding balance of the mortgage. The more equity that is available, the higher the amount of financing that will be offered by the lender.
Do I Need a Bad Credit Secured Loan?
In some situations, a secured loan for bad credit may not be necessary. The maximum unsecured loan amount is £25,000 with a maximum repayment term of 10 years. If the amount is under that, an unsecured loan may be preferable, but it will cost more.
An unsecured loan for the maximum value of £25,000, with an example interest rate of 4.88%, repaid over a 10-year term would cost around £264 per month.
Using the same illustrative figures but changing the repayment terms to a 20-year term, the monthly payments would be £163, however as the repayment term is longer than the 10-year term, it would need security.
For amounts over £25,000, it will need to be a secured loan. Amounts under the maximum threshold for unsecured (personal) loans, there is a choice between the two.
Use an online mortgage calculator to work out the monthly repayment costs. If that is higher than can be comfortably afforded, extending the repayment terms will lower the monthly repayment amounts; however, it will raise the lifetime cost of the loan.
How Can I Get the Best Interest Rates for Homeowner Loans with Poor Credit?
Secured homeowner loans, even for those individuals with poor credit, can be much more affordable than traditional bank loans. Once a lender and loan package has been found that meets the borrower’s needs, they will need to use a bad credit comparison table or secured homeowner loans calculator to find the cheapest interest rate options.
It is important to keep in mind that although long term loans have a lower interest rate, those interest payments will add up over time and can add a significant amount of money to the total amount you will be repaying by the end of the loan.
What Loan Repayment Term Should I Request?
The duration of the repayment period for a secured loan with a bad credit score is generally more negotiable than the actual amount of funding being borrowed. Most lenders who provide secured loans will offer repayment periods between 3 and 25 years.
When thinking about what repayment term to request, consider how much your budget will afford you to pay in monthly repayments. Also, take the time to compare different lenders repayment requirements to help find the best possible deal.
The longer the repayment term is, the more favourable the interest rate will be, because you will not be able to switch during that time, without incurring a penalty charge for early settlement/repayment.
Shorter term bad credit secured loans attract higher interest rates. However, borrowers are best to consider the likelihood of credit reports improving.
All entries on a credit report, held by Credit Reference Agencies, Experian, Equifax and Call Credit drop off automatically after six years.
For those with bad credit, measures should be taken to maintain positive finance accounts to encourage good status reporting. Maintaining a healthy credit file consistently for six years will improve credit ratings and lower the risk to lenders.
Factoring for improvements to credit files, the length of repayment term for a home loan with a higher than average interest rate attached to it, it may be worth considering a maximum of six-year repayment terms.
This will provide a time frame to maintain positive accounts reporting, improving credit ratings so that when the repayment term is met, a secured loan for bad credit won’t be required and a lower interest rate able to be taken advantage of, in addition to being able to access more lenders.
When considering the duration of repayment terms, lenders also have upper age limits that need accounted for before applying. This is based on the age of the borrower when the deal ends. Nationwide Building Society raised their upper age limit to 85 in 2016. The Royal Bank of Scotland, Barclays and Natwest all have an upper age limit of 70.
As every application for credit has an impact on credit reports and risk assessments, it is worth researching mortgage providers to find out what the age limits are. For a person aged 50 applying for a secured loan over a 25-year term with a lender using an upper age limit of 70, by the end of the repayment term, they would be over the upper age limit resulting in the application being denied.
As lenders are now extending the repayment terms beyond the traditional 25-year mortgage, in some cases as long as 40-year mortgages, it could mean that anyone over the age of 30-years old could be pushing close to the upper age limit without knowing or considering it and applying based on the attractive lower monthly costs of repayments.