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

The term covers borrowing money and making regular payments until the debt — including any interest — is repaid. Crucially, you don't put up anything valuable as collateral.

Examples include personal loans, student loans, utility bills, payday loans, credit cards and overdrafts.

Secured vs unsecured debt#

The headline difference is collateral. Unsecured loans require none, unlike secured loans such as mortgages. Collateral is security for the lender — usually your home — in case you default.

Beyond that, three areas differ.

Approval#

Unsecured approval rests on your credit history, income and your commitment to making repayments in full until the end of the term.

Secured loans require an asset as collateral. Because that gives lenders security, people with adverse credit histories may find secured loans easier to get approved for.

Collateral is usually your home, but it could be a vehicle, jewellery or another valuable asset. With car financing, the car itself becomes the collateral.

The process for unsecured loans is generally quicker, since there's no asset valuation. Lenders prioritise your credit history instead.

Terms#

Lenders typically consider secured loans less risky because of the collateral, so they're generally willing to lend larger amounts over longer periods.

Interest rates on secured loans also tend to be lower. But a longer term means a secured loan's interest can cost more overall, even at a lower rate.

Some secured loans carry variable interest rates, so your monthly payments can rise with the Bank of England base rate (opens external site). That's true of some unsecured debt too, such as an overdraft.

What happens if you default#

Fail to meet a secured loan's terms and the lender may eventually repossess your home or another asset to recover the debt. That process has several steps and is usually a last resort.

With unsecured loans, your house isn't immediately at risk if you fall into arrears. You're still required to repay on time, though. Missed payments on both types bring penalty fees and a negative marker on your credit report.

Most lenders send a notice of default after around six months of missed payments or underpayments on unsecured debt, which should give you two weeks to make them up. If you can't, the account defaults and the lender may pass the debt to a collection agency or take court action.

What to keep in mind#

Your credit report. What's on it will shape the outcome of your application, so monitor it and work on keeping it in good shape.

Lenders may run checks through any one — or several — of Experian, Equifax and TransUnion. So it's worth verifying that all three are reporting your information correctly.

How you manage the loan affects your future. Regular on-time repayments improve your score and widen your access to credit. Missed or late payments bring penalty fees, accrued interest and score damage. Before taking one on, consider honestly how easy the repayments will be.

Does your score determine approval?#

For unsecured loans, lenders lean heavily on your credit history to gauge whether you'll meet the terms. Your score reflects that history, so well-managed borrowing produces a higher score.

Lenders each have their own criteria and formulas, so some may view your report more favourably than others. But negative markers like missed payments or CCJs are universally treated as adverse credit history.

There are specialist lenders for people with adverse credit or thin files. They typically offer less favourable terms — higher interest, lower limits — to offset the perceived risk.

According to House of Commons Library data (opens external site), a substantial share of UK adults used some form of consumer credit in 2020, and the trend suggests that number is growing.

The key things to remember#

  • Unsecured debt needs no collateral; secured debt does.
  • Credit cards, overdrafts, utility bills, store credit and mobile contracts are all unsecured.
  • Secured loans usually mean larger amounts, longer terms and lower rates.
  • A longer secured term can still cost more in total interest.
  • Default on a secured loan risks your home; unsecured default doesn't, immediately.
  • Notice of default typically arrives after around six months, with two weeks to catch up.
  • Specialist lenders exist for adverse credit, at higher rates and lower limits.