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Secured loans can help borrowers access much-needed cash or make major purchases, such as a house or a new car, often with less stringent qualifying requirements than unsecured loans. By pledging valuable assets, a borrower can obtain financing while keeping interest rates low. Lenders also face less risk when providing secured loans as they can foreclose or repossess collateral if the borrower defaults.
What is a secured loan?
A secured loan is a loan secured – or secured – by a valuable asset, such as real estate, cash accounts, or an automobile. In many cases, the loan is secured by the underlying financed asset such as a house or vehicle; alternatively, borrowers may be able to pledge other collateral like investments or valuable collectibles.
If a borrower defaults on a secured loan, the lender can repossess, seize or otherwise seize the asset to collect the outstanding balance. For this reason, secured loans pose less risk to lenders and therefore often come with lower interest rates and borrower requirements than unsecured loans.
Secured or unsecured loans
For example, in the case of secured and unsecured personal loans, a borrower with a high credit rating may qualify for a low interest unsecured loan without having to give collateral. Another applicant for the same unsecured loan might not qualify and need to rely on a secured option because it is more risky. One type of loan isn’t necessarily better than another, but it’s important to understand your options before signing on the dotted line.
How secured loans work
Secured loans give borrowers access to a lump sum of cash to cover everything from home improvement projects to buying a car or a house. You can usually get these loans from traditional banks, credit unions, online lenders, car dealers, and mortgage lenders.
Even though secured loans are less risky for lenders, the application process usually requires a rigorous credit check, although some lenders offer the option to prequalify with a simple credit application. And, although secured loan balances bear interest like other loans, borrowers can access lower annual percentage rates (APRs) than those available with unsecured options.
Once a borrower qualifies for a secured loan, the lender places a lien on the borrower’s collateral. This gives the lender the right to seize the collateral if the borrower defaults on the loan. The value of the collateral should be greater than or equal to the outstanding loan balance in order to improve the lender’s chances of recovering their funds.
What can be used as collateral on a secured loan?
Often times, the type of collateral required for a secured loan is tied to the underlying purpose of that loan. This is particularly illustrated by mortgages, in which the home loan is secured by the financed house. Having said that, a suitable collateral can also depend on a number of other factors including the lender and the loan amount. Common forms of guarantee include:
- Real estate, including homes, commercial buildings, land and real estate equity
- Bank accounts, including checking accounts, savings accounts, certificates of deposit accounts (CDs), and money market accounts
- Investments like stocks, mutual funds and bonds
- Insurance policies, such as life insurance
- Vehicles ranging from cars, trucks and SUVs to motorcycles and boats
- Other valuable assets like precious metals, coins and collectibles
- Machinery, equipment, inventory and other business assets
What if you are unable to get a secured loan?
If you default on a secured loan, your lender can seize the collateral to collect the outstanding loan balance. In the case of a mortgage, it is about filing a foreclosure action against the borrower. If you default on a car loan, the lender can repossess the financed vehicle. In general, the value of the collateral for the underlying loan must meet or exceed the loan amount, which improves the lender’s chances of limiting their losses in the event of default.
However, there are certain circumstances in which the loan balance may exceed the value of the collateral. For example, if you buy a house during the height of the real estate market and fail to pay off your mortgage during an economic downturn, the bank might not be able to recover the mortgage amount through a sale. foreclosure. When the sale of the collateral does not cover the entire outstanding balance of a loan, the lender may attempt to recover the remaining amount by filing a judgment of insufficiency.
If you have a secured loan and think you might default, you can take steps to limit the negative impacts on your credit score. Contact your lender immediately, review your budget, and prioritize secured loan payments so you don’t lose your home or other valuable collateral.
Types of secured loans
Mortgages and auto loans are perhaps the most well-known secured loans, but there are a number of other financing options that may require collateral. Here are the most common types of secured loans:
- Mortgages. Mortgages are a type of loan commonly used to finance the purchase of a house or other real estate. These loans are secured by the financed property, which means that the lender can foreclose in the event of default by the borrower.
- Home equity lines of credit. A Home Equity Line of Credit (HELOC) is a revolving loan secured by the borrower’s home equity. The borrower can use the funds as per his requirement.
- Home equity loans. Like a HELOC, a home equity loan is secured by the borrower’s home equity. With a home equity loan, however, the borrower receives a lump sum of cash, on which interest begins to accrue immediately.
- Auto loans. Auto loans are secured by the financed vehicle. To protect its interest in the collateral, a lender holds ownership of the financed vehicle until the loan is fully repaid.
- Guaranteed personal loans. Secured personal loans allow borrowers to access cash that can be used for personal expenses such as home renovations, vacations, and medical expenses.
- Secure credit cards. With a secured credit card, a borrower has access to a line of credit equal to the amount of money he commits as a security deposit. This makes these cards a great option for borrowers who are trying to improve their credit rating.
How to get a secured loan
Secured loans are generally available from traditional banks and credit unions, as well as online lenders, car dealers, and mortgage lenders. Follow these five steps to get a secured loan:
- Check your credit score. Before applying for a loan, check your credit score using a free online service or your credit card provider. Once you’ve familiarized yourself with your score, use the information to pre-qualify for a loan or take action to improve your score and your chances of approval.
- Review your budget. If you are considering a secured loan, it is also helpful to review your budget to determine what you can afford to pay each month. It is always important to take existing debt repayments into account when taking out a new loan.
- Evaluate the value of potential collateral. When you’re ready to buy a loan, assess the value of your potential collateral, including cash account balances, home equity, and any other valuable assets, to see how much you can borrow.
- Shop around for the best loan. After assessing your credit score and how much money you can afford to borrow, start looking for lenders. If you are considering a HELOC loan or home equity loan, contact your current lender to learn more about your options. If you are considering applying for a secured personal loan, look for lenders who offer a no-credit screening.
- Submit a formal request. Once you’ve prequalified with a lender, submit a formal application. Unlike the unsecured loan application process, lenders who offer secured loans will likely need an appraisal to confirm the value of your collateral before extending the loan.
Benefits of secured loans
- You may be able to access lower interest rates with a secured loan than with an unsecured alternative
- It might be easier to qualify as secured loans pose less risk for lenders
- Borrowers can take advantage of tax deductions for interest payments on certain secured loans, such as mortgages
Disadvantages of secured loans
- If you do not repay the loan, your collateral could be repossessed or foreclosed on.
- The borrowing is less flexible because the authorized uses of the loan are often linked to the collateral itself