What Is a Secured Loan?
“Secured loan” is a broad term that encompasses different types of loans that use the borrower’s property as a form of financial protection for the lender. Mortgages, home equity loans and auto loans are all common examples of secured loans.
In the case of a mortgage or home equity loan, your house is the collateral that secures the loan. In an auto loan, it’s your car. If you fail to make your payments on a mortgage or home equity loan, you can lose your home to foreclosure. If you can’t keep up with your auto loan payments, your car could be repossessed.
This sets secured loans apart from most top personal loans. In general, a personal loan is unsecured — meaning it has no collateral requirements. The amount you can borrow and the terms you’re offered are based on your creditworthiness and income, instead.
However, you may also run into secured personal loans. These are generally harder to find, but typically require a car or financial account like a certificate of deposit or money-market account to be used to secure the loan’s value.
How Does a Secured Loan Work?
Secured loans work just the same as any other type of loan. Your lender will offer you a certain loan term and interest rate, and you pay back your loan according to a set schedule.
However, there are some aspects that set secured loans apart. Most secured loans offer lower interest rates than unsecured loans because the collateral makes them less risky to the lender. For example, home mortgages usually have lower interest rates than credit cards, in part because your house backs it up.
It is also generally easier to qualify for a secured personal loan than it is an unsecured loan — so these loans may be an option for you if you have a lower credit score.
Types of Secured Loans
There are a wide variety of secured loans on the market that you may run into. Here are a few of the most common.
Mortgages
Mortgages are one of the most commonly recognized secured loan and are used to finance the purchase of a home. The house itself serves as the collateral securing the loan, meaning that lenders can start foreclosure proceedings against the home if the borrower fails to repay the loan.
Home Equity Loans and Home Equity Lines of Credit (HELOCs)
Home equity loans and HELOCs are types of secured loans that you can apply for based on your home’s value and the amount you have paid toward your mortgage. Each of these loans uses your home as collateral, so you’ll be at risk of going into foreclosure if you miss payments.
With home equity loans, you’ll receive one lump sum that is paid back over an agreed-upon loan term, typically at a fixed rate of interest. In contrast, HELOCs are a revolving credit line that you can use, much like how you use a credit card.
Auto Loans
Auto loans utilize the value of the car or vehicle to secure the loan. Like with a mortgage, failure to pay the loan can result in a lien against the vehicle and the lender repossessing your vehicle.
Secured Credit Cards
Secured credit cards are similar to traditional credit cards, but they are backed by an initial security deposit. You entrust the lender with a certain amount of cash, and they give you a credit limit. You’ll get your money back after you close your account if your balance is fully paid. But if you fail to make your payments, your lender will use the security deposit to pay back your balance.
The deposit is often equal to your credit limit on the card. For example, to get a secured credit card with a limit of $1,000, you would need to deposit $1,000.
However, in some cases, you may be able to find a secured credit card that allows you to make a deposit for a percentage of your credit limit. In this case, if you want a credit card with a $1,000 line of credit, you would put in a security deposit valued at a couple of hundred dollars.
Bad Credit Loans
Bad credit loans is a broad term that can refer to secured personal loans. Bad credit loans help people with little to no credit improve their credit scores and get financing. Borrowers usually are required to secure these loans with something valuable, as discussed earlier.
Pros and Cons of Secured Loans
The big advantage of a secured loan is that lenders generally consider them safer. If you have bad credit, lenders may be more willing to loan you money if you pledge collateral to secure the loan.
While interest rates vary depending on the lending institution, most interest rates are lower for secured loans than they would be on an unsecured loan because they’re backed by collateral.
The main disadvantages of secured loans include the potential to lose your collateral. Failure to pay back your loan could mean you lose your house, car or financial account — whatever you pledged as security on the loan.
How Do I Get a Secured Loan?
Secured loans can be harder to find, but they are possible to obtain if you know where to look. You can start with your existing bank or credit union, though there are some online-focused lenders that offer secured loans, as well.
Consider the following steps before taking out a secured loan:
- Know your credit score: Knowing where you stand is always a good first step. Your credit score should give you a better idea of what type of loan you are likely to qualify for. If your credit score is high enough, you may not need a secured loan at all.
- Consider your collateral: With a secured loan, the amount you are able to borrow will typically be based on the value of your collateral. You may want to have the property appraised ahead of time.
- Compare lenders: Based on your credit score, you can put together a list of lenders who offer loans to people in your range. Many of these lenders will allow you to prequalify and receive a loan offer specific to you. This will help you weigh different loan options against each other to find the best one.
- Apply for a loan with the best lender for you: With multiple loan offers in hand, you can determine which one is the best fit. The lender should give you instructions on how to move forward with a full loan application.
How Long Do Secured Loans Last?
Secured loan terms range from as short as a few months to as long as 30 years or more, in the case of a mortgage loan. The length of the loan term can vary by lender, and will also depend heavily on the type of collateral used for the loan.
What Happens if I Default on a Secured Loan With My Lender?
Defaulting on a secured loan can result in you losing the collateral you pledged when you took out the loan. For example, if you fail to pay a loan secured by your car, you may lose the car. Your lender may sell the car to repay the debt.
It’s important to note that missing a monthly payment is not the same thing as defaulting on a loan — but making late payments could mean you are in default. Missing a payment can impact your credit score but may not immediately result in losing your collateral.
The Bottom Line
Secured loans can be beneficial depending on your financial situation. They’re generally easier to qualify for, which is especially valuable if you have bad credit. Paying them back on time can also help you build your credit score.
But secured loans also carry hefty penalties if you don’t repay your loan. Remember, secured loans are backed by your home, car or other valuable assets. Fail to make your payments, and you could lose them. You should likely only seek out a secured loan after doing the math and ensuring you can make the proper payments.
Frequently Asked Questions About Secured Loans
You may have an easier time qualifying for a secured loan than an unsecured loan. Start by checking your credit score. Next, shop around and weigh your options. Once you have your offers, start filling out official loan applications.
Getting a secured loan can negatively impact your credit score initially. This is usually because the lender performs a hard credit check which impacts your credit rating. Although, if you make all your payments on time, a secured loan can improve your credit score over time.
Having a good credit score is helpful when applying for a secured loan, especially if you’re applying for a mortgage or car loan. However, you may have an easier time qualifying for a secured personal loan than a traditional personal loan if you have bad credit.
Secured loans generally take longer to close — meaning you’ll be waiting longer to get your money. It’s always best to consider all options available to you and ensure you’re capable of paying back your secured loan rather than rushing the process and making a mistake.
Editor’s Note: Before making significant financial decisions, consider reviewing your options with someoneyou trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.
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