What is unsecured debt?

You might be surprised to learn that, in most cases, unsecured debt is simply a personal loan.  

The term, which is also known as ‘unsecured loans’, covers borrowing money from a lender and making regular payments until the debt (including any owed interest) is paid off. Most importantly, you don't need to put up anything valuable as collateral to get the loan. Some examples of unsecured debt include personal loans, student loans, utility bills, payday loans, credit cards, and overdrafts.  

Let’s explore the difference between secured and unsecured debt, including their terms, approval processes, and the consequences of missing repayments. We’ll also shine a light on the importance of your credit report and credit score for unsecured loan applications.  

Secured vs unsecured debt: What’s the difference? 

The first and possibly most important difference is that you aren’t required to put up collateral to get an unsecured loan, unlike with secured loans (such as mortgages). Collateral is a form of security, usually your home, for the lender in case you default on the loan.  

The other key differences between secured and unsecured loans lie in three main areas – approval, terms, and what happens in the case of default. 

Approval 

Approval for an unsecured loan is based on information such as your credit history, income, and your commitment to making the repayments regularly and in full until the debt and any interest owed are repaid by the loan’s end term. 

On the other hand, secured loans require borrowers to put up an asset as collateral for the loan. Since this provides lenders with security, people with adverse credit histories may find it easier to get approved for a secured loan.  

Collateral is usually your home, but it could also be a vehicle, jewellery, or another valuable asset. For example, in the case of car financing, the item (car) being financed becomes the collateral for the financing. 

In general, the process for unsecured loans can be quicker and easier than secure loans, as you won’t need to go through a valuation process for your assets. Instead, lenders usually prioritise your credit history in their decision to approve you for an unsecured loan. 

Terms

While each lender has their own terms and limits, lenders typically consider secured loans less risky than unsecured loans because they involve collateral. This means lenders are generally more willing to lend larger amounts, and over a longer period of time, through secured loans.

Interest rates on secured loans also tend to be lower than on unsecured loans. But while the interest rates may be lower, the longer loan term can mean a secured loan’s interest could cost more than an unsecured one’s over time.  

Some secured loans also have variable interest rates, which means your monthly payments can change and increase according to the Bank of England base rate; this can be true for unsecured debt like an overdraft. As always, it’s important to make sure you fully understand the terms of any credit agreement and how your interest rates may change before signing off on it. 

In the case of default

If you’re unable to meet the repayment terms of a secured loan, the lender may eventually repossess your home or another asset to recover the debt. However, this process has several steps and it’s usually a last resort for lenders.   

With unsecured loans, your house or asset isn’t immediately at risk if you fall into arrears. But you’re still required to make repayments on time and according to the payment terms. Missed payments on both secured and unsecured loans can result in penalty fees and a negative marker on your credit report, negatively impacting your credit score and any future lending.   

Most lenders will send you a notice of default usually after six months of missed payments or underpayments on your unsecured debt, which should allow you two weeks to make them up. If you can’t pay, the account defaults and the lender in question may pass the debt to a collection agency, or even take court action against you.  

What to keep in mind with unsecured loans 

If you’re planning to apply for an unsecured loan, here’s what to keep in mind.   

• Your credit report. The information contained in your credit report will impact the outcome of your loan application, so it’s best practice to continuously monitor your credit report and work towards keeping it in good shape over time.

  Lenders may run credit checks through any one (or multiple) of the UK’s major credit reference agencies (CRAs)– Experian, Equifax, and TransUnion. So, it’s best to verify that all three CRAs are correctly reporting your information, which you can conveniently do with Checkmyfile. Your Checkmyfile report compiles all your information held by the three CRAs, so you know where you stand.

• How you manage the loan can affect your credit history and financial prospects. Making your unsecured loan’s repayments regularly and on time helps improve your credit score, increasing your access to future credit. On the other hand, missed or late payments have negative consequences, such as penalty fees, accrued interest, and a negative impact on your credit score.     If you’re planning to take on an unsecured loan, you might want to consider how easy it’ll be for you to make the repayments and comply with the payment terms. 

Does your credit score determine if you can obtain an unsecured loan?

 For unsecured loans, lenders rely largely on your credit history to gauge the likelihood of you being able to meet the repayment terms. A credit score reflects your credit history, so a credit report that demonstrates well-managed borrowing translates to a higher score.  

Lenders have their own criteria for evaluating your credit history and different formulas for calculating credit scores, so some may view your report more positively or negatively than others. However, negative markers, such as missed payments or County Court Judgments (CCJs), are universally considered adverse credit history, and lenders will view them negatively.   

Fortunately, there are specialist lenders for people with adverse credit histories or those with little-to-no credit history. These lenders may offer comparatively less favourable terms, though, such as higher interest rates and lower credit limits, to reduce the perceived risk of lending. 

Unsecured debt: The takeaway 

According to survey data, more than half (57%) of adults in the UK used some form of consumer credit in the year 2020, with trends suggesting that number is likely to grow. If you’re one of the many consumers considering unsecured or secured debt, it’s important to familiarise yourself with the approval process, loan terms, and repayment terms.  

Unsecured debt is money you owe that isn't backed by something valuable you own, like your house or car. Examples include credit card balances, utility bills, bank overdrafts, store credit cards, and mobile phone contracts. This debt is paid off over an agreed-upon period of time through regular payments until the loan (and any interest owed along the way) is paid off.