When you apply for a loan, one of the first questions is whether it will be secured. The answer often has a bigger effect on the rate than almost anything else you can control.
What "secured" means
A secured loan is backed by an asset, such as the car, trailer or equipment you are buying. If you stop repaying, the lender has a legal right to take and sell that asset to recover what is owed. An unsecured loan has nothing behind it except your promise to repay, so if things go wrong the lender has a harder and slower path to recovering its money.
That difference is the main reason secured loans are usually offered at lower rates. The lender is carrying less risk, and it prices accordingly. The Australian Securities and Investments Commission explains the basics of borrowing at ASIC and MoneySmart.
A worked example
Take a $25,000 loan over five years. To show the effect, assume an illustrative secured rate of 8% a year and an illustrative unsecured rate of 13% a year. These are examples to demonstrate the principle, not rates you should expect.
| Secured at 8% | Unsecured at 13% | |
|---|---|---|
| Monthly repayment | $506.91 | $568.83 |
| Total repaid | $30,414.59 | $34,129.61 |
| Total interest | $5,414.59 | $9,129.61 |
The unsecured loan costs $61.92 more every month and $3,715.02 more over the five years. For the same $25,000, that is a large amount of money, and it is entirely explained by the risk the lender is pricing in.
The catch: what you put at risk
Lower cost is not free. With a secured loan, the asset is on the line. If you cannot keep up repayments, you could lose it, and if the sale does not cover the debt you may still owe the difference. An unsecured loan does not put a specific asset at stake, although a default will still damage your credit file and the lender may take legal action to recover the debt.
So the right question is not simply "which is cheaper?" but "which risk am I more comfortable carrying?"
Other things that differ
- Eligibility. Lenders usually want the secured asset to meet certain conditions, such as age, type or condition. Older assets can be harder to secure against.
- Loan size. Unsecured loans are often capped at lower amounts than secured ones.
- Insurance. Secured loans often require you to insure the asset, which is an extra cost to add to your comparison.
- Flexibility. Selling the asset before the loan ends normally requires paying out the loan first.
Reading the offer properly
When you receive quotes, check:
- Is the quoted rate for a secured or unsecured loan?
- What is the comparison rate, and what loan size does it assume?
- What are the fees, and what happens on early payout?
- What happens to the asset if something goes wrong?
You can test the figures yourself in the repayment calculator. Enter $25,000, five years, and compare 8% against 13%; you should see the same repayments as the table above.
The bottom line
Security usually buys a lower rate, and in dollar terms the difference can be thousands over the life of a loan. It also raises the stakes if your circumstances change. Before choosing, work out what the cost gap is in dollars, and what you are putting behind the loan to earn it.
This article is general information with illustrative figures. It is not advice or an offer of credit.
