Times are tough. You don’t have to look further than your own finances to know that. According to TransUnion’s most recent Industry Insights Report, consumer debt has increased sharply in the past 12 months. The worrying trend is that ordinary South Africans are using credit cards and personal loans just to cover everyday expenses such as their groceries and fuel.

When you do this, you are using future earnings to pay for today’s expenses. There are two main types of credit available to help you through hard times – secured, and unsecured. Let’s have a look at the key differences, and what they mean to you.

Secured Credit

In simple terms, secured credit means the bank, or the lender, holds one of your assets in exchange for giving you the loan – like your car, or your home. So your home is the ‘security’ for your home loan: if you don’t pay your bond, the bank will sell your house to cover the money they lent you. The same applies to your car.

Pros:

• Secured credit carries fewer risks for the lender, because they have an asset that covers the loan. That means this type of loan carries a lower interest rate.
• If you need funds urgently, you can often draw from the access bond on your home, instead of taking a standalone personal loan. That way, you’ll pay lower interest rates.
• It’s a good idea to insure your car and home, so they will be paid off if anything happens.

Cons:

• If you don’t pay back your loan, you could lose your car or home, and all the premiums you paid until then. In the worst case, you could lose your car or your house and still end up owing the bank money, if they were not able to recover the total outstanding amount.
• If you default, your credit rating will be affected negatively, which means you will battle to get credit in the future.
• Make sure that if you are taking money out of your home loan, you pay it back quickly. It might look like a small repayment amount each month, but when you calculate it over the duration of your home loan, you pay a huge amount in interest.

Unsecured Credit

Unsecured credit means the bank, or the lender, doesn’t have any asset to hold onto in exchange for giving you a loan. The risk for the lender in this instance is much higher than secured credit and therefore the lender needs to attach a higher interest rate to these loans. However, unsecured credit is useful when you need to cover an emergency expense or smaller expenses such as furniture, travel or electronic goods.

Examples of unsecured credit are credit cards, microloans, personal loans and retail store accounts. Basically, they’re accepting your promise to pay them back in the future. That’s why unsecured loans are usually based on your credit history and payment behaviour amongst other factors applied by the lender.

Pros:

• There’s no collateral required. You don’t have to offer an asset to back the loan, which generally means you can’t lose your house if you default.
• The processing time is far quicker than for an unsecured loan. Banks and lenders will generally give you an answer within a couple of hours.

Cons:

• Interest rates are much higher than secured credit. Which also means that loan amounts that are granted are usually smaller than secured.
• It’s easy to overspend. If you’re not disciplined with your credit card, you can quickly find yourself in over your head, and unable to meet the repayments.

The bottom line is that it’s important to understand what you require credit for, and whether you can afford the monthly repayments before you make any commitments as late or non-payment of these credit agreements will affect your credit rating. Your financial health depends on it.