Why do banks prefer secured loans?

There are several reasons why borrowers prefer to take a secured loan over an unsecured loan.

The first, of course, is the lower interest rate, which makes it easier for these individuals to make the payments. The second reasons is because the loan amount can vary depending on the amount of equity you have in your home, while unsecured loans tend to have limits that could make it difficult to pay for whatever it is you need. The final reason is the trustworthiness of loans - secured loans tend to have less additional fees and penalties.
While we know why borrowers prefer secured loans, why is it that lenders prefer secured loans as well?

 

Risks

All lending comes with a risk. If a lending company gives you £10,000, and you do not pay it back, they are the ones that lose. Even though they will try their best to get you to pay them back, even going so far as to go through the court system and try to get your assets liquidated, they do so at substantial cost to themselves, likely causing them not only to not profit from your loan, but to actually take a significant loss.But by lending off your home's equity, that risk is significantly reduced. For starters, you - as the home owner - are far less likely to miss payments with your house on the line. Without your house put up as collateral, you can skip town, move to another country and never see these lenders again. There is nothing forcing you to pay back the loan (at least not until the courts force you to file for bankruptcy) and many people take advantage of this by not paying the banks back, resulting in significant loss for the lending industry.

Secondly, when someone defaults on an unsecured loan, even if the courts require the person's assets liquidated there is still no way of knowing if the loans will be paid back in full. But lending off your home is different - because your home's equity is the loan debt, in a sense, and banks and lending companies know that if you refuse to pay it back, they will easily be able to sell your house and get the money they are owed back.

Reward

In addition, this security allows these banks to offer lower interest rates , because the lower risk means that they will be far less likely to lose money. While it may seem counterintuitive, banks are happy to offer lower interest because you will be far more likely to pay it back, which will ensure that they receive their profit. To use an analogy, say a box of cereal costs a grocery store £2.00 wholesale. They have to choose what they charge for the box of cereal. If they know that at £3.00 per box they can sell 10, and for £4.00 per box they can sell four, although the £4.00 per box represents a greater, per box profit, the £3.00 per box is able to sell better and results in greater profits over time. With this lending method, the bank will be able to safely lend out more money, and although the interest rates will be less, the profits will be greater and they will be able to ensure they are not cheated in the process.

Secured loans are great for borrowers, but they are also preferred by lenders as well, who see them as a far safer way to lend money to individuals in need of a loan.




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