Loans have been in existence since before people began using hard currency to trade and make their fortunes. Loans between merchants and farmers are mentioned in the bible and once interest began to be added to the loans, this form of making money began to be on the increase. However, before looking at the history of secured loans, it makes sense to ask some crucial questions such as what is a loan? What is a secured loan? What is collateral? Who is eligible for a loan? And, when should a secured loan be taken out?
Secured Loans Explained
A loan is an amount of money borrowed by one person from another person (or more usually an organisation like a bank). In return for the lender supplying the funds, the borrower undertakes to pay the money back within a certain time limit and interest is added to the amount owed. This is the way that the lender makes a profit. There are different types of loans but the most useful one for borrowing large sums of money over a long time period is the secured loan.
A secured loan is granted when the borrower offers some kind of collateral to the lender. i.e. an item that can be sold to cover the amount owed. One of the earliest types of secured loan was issued by the pawnbroker who would take an item like a ring or watch and lend money against it. The pawnbroker would lend a specific amount say £50 and the borrower would pay back that sum plus interest within a certain time frame, usually 6 months.
When a mortgage is taken out it is usually the house that is the collateral and if you buy a car it is the car. However, there are other kinds of collateral that can be offered to obtain a secured loan. Items such as a boat, jewellery, works of art, tools or business premises and even stocks and shares are sometimes used as collateral to obtain a long term loan. The advantages of obtaining a secured loan are that the term is usually a longer period than that offered for unsecured loans and the interest rate is lower. Secured loans are less of a risk to the lender and this is why the terms are more favourable.
In the UK, the biggest market for secured loans is for mortgages to buy houses. People who want to buy a house must fit the criteria demanded by the lenders (usually a bank). They must place a deposit of up to 20% of the purchase price of the property and demonstrate that they can meet the monthly payments that are required to service the loan. The lender registers an interest (called a charge on the property). The lender is not taking a high risk as if the borrower does not make the payments and falls behind on the debt then the lender can take possession of the property and sell it to cover the amount of money that has been borrowed.
In order to be eligible for a mortgage you will usually have to prove that you have been in steady employment for a certain length of time and have no bad credit events in your history. That is, you must not have defaulted on a previous loan of any kind. This is why a good credit history is so important. It enables you to take a step on the housing ladder and buy your first home. If you are thinking about buying a house and need a mortgage, in the first instance you should approach your bank or get advice from a mortgage broker about the amount you can borrow. Typically, a mortgage will be granted over 20, 25 or even 30 years.
One important point to remember about a secured loan like a mortgage is that if you do default on the payments then you could still end up owing money. If the lender sells the property and the amount does not cover the debt owed then the original borrower must make up the difference. This situation can happen when the housing market takes a dip and houses suddenly become worth less than the amount that was paid for them. This is why it is vital not to overextend yourself when it comes to borrowing money. Secured loans have enabled families all over the UK to buy a home and a mortgage is still the most viable option for most people when it comes to buying a property.
Interest Rates For Secured Loans
Signing up for a secured loan is an excellent way to establish a good credit record. In addition, the rates of interest for secured loans are a lot more favourable than those offered for unsecured loans. If you have already established a good credit history you will be offered a lower rate of interest than that offered to people who have an unreliable credit record. Secured loans are available with fixed rates of interest, variable rates of interest and rates that track the stock market. Fixed rates can be for time periods of 2, 3, 5 or 10 years and if the interest rates are low when you take out the loan and you have a steady income, fixed rates can be a good option. You know exactly what you will be paying for a specific period of time and this will allow you to budget so that payments are easily made.
Variable rate secured loans are just that. The amount of interest charged can go up or down according to the rates charged by the lender. Therefore, it is important to only use a responsible lender who provides good rates and no hidden fees. When banks want to attract savers, they will invariably put up rates and this is bad for borrowers. Rates for the last 7 years have been kept very low so a variable rate mortgage at the present time is not a problem. However, if and when banks decide to start charging more interest and rates get higher you should be prepared for a hike in the amount owed if you have taken this option.
A tracker rate secured loan is another type of mortgage and this one is also variable and tracks the rise and fall of the interest rate of the Bank of England. Tracker rates may be an introductory rate from one year to five years or it could be a lifetime tracker rate. Some versions of this type of secured loan will offer a rate below the BOE rate and as that has been as low as 0.50% for many months it means that a considerable amount of mortgage holders are paying practically no interest on their secured loan.
Some mortgages are taken out on an interest payment only scheme which means that at the end of the term you will still owe the full amount of capital that you borrowed. When house prices were rising fast this was seen as a good option for people who has a limited amount to spend each month. The idea behind this type of secured loan was that the increase in the value of the property would pay off the capital at the end of the term of the loan.
Secured Loans for a Business
Secured business loans can also be a good way to get some capital to expand a new business. You can use the business premises or tools and equipment as collateral for the loan and rates will be determined by the risk that the lender is taking. A secured business loan will be based on the Loan to Value ratio. The property is valued and the lender will decide how much you can borrow. Typically, this could be 85% or it could be up to 100%. Whilst it is tempting to borrow against your own home to plough extra money into a business venture, this is very unwise as your home will be at risk if the venture is a failure.
In the past it was possible to offset some of the interest from a domestic mortgage against your income tax. This was called MIRAS (mortgage interest relief at source) and it applied to variable amounts up to £30,000. However, this was abolished in April 2000 and now all interest on home mortgages are not subject to any relief of income tax. Business loans are a different matter and interest payments can be claimed against business tax as a deductible expense.
Read more about the history of loans, online loans and credit here.