Secured loans are loans that require property or assets to “secure” the loan. Not every loan needs collateral but in some instances, it’s required. Collateral can be an asset, money, property, or something else.
If you’re debating whether to get a loan that is secured or unsecured, keep reading to understand exactly what a secured loan is and how it works.
What Is a Secured Loan?
A secured loan is when a lender requires you to use a piece of property, an asset, or money as collateral to get funding. Some examples of a secured loan include:
- Home equity loans
- Car-title loans
- Auto loans
Your collateral usually comes into play if you don’t make payments and your account goes into default (more on that later).
How a Secured Loan Works
Secured or not, loans allow you to borrow money to buy something now, and then repay it later, usually on a monthly basis.
You can find secured loans from just about any lender that provides loans to consumers. Most lenders will offer traditional secured loans like mortgages and auto loans. However, there are alternatives. For instance, Wells Fargo offers secured loans where you can use your savings or CD account as collateral.
Most secured loans require a credit check. That means lenders will determine your interest rate based on your credit history and credit score. Interest rates for secured loans tend to be lower compared to unsecured loans since you’re using an asset to secure your loan.
If the lender approves your loan, you get the money but the lender places a “lien” on your collateral. Basically, a lien gives the lender rights to the property.
Should you fall behind on payments and go into default, the lender has a right to repossess your property because of the lien. To recoup the cost of your loan, the lender may sell the asset it seizes.
The following calculator can help you understand what you monthly payment will be so you can avoid offers that overextend your budget:
Even if your lender resells your assets, the money from the sale may not cover the full amount of what you owe on the loan. At that point, the lender could pursue you for the remaining balance.
Secured Loans vs. Unsecured Loans
While secured loans require collateral, unsecured loans don’t have a requirement to secure the loan. Instead, lenders give out loans based on your creditworthiness. Secured and unsecured loans have a few key differences:
|Secured Loan||Unsecured Loan|
|Credit Score||Uses credit score to determine eligibility and interest rate||Uses credit score to determine eligibility and interest rate|
|Collateral||Requires collateral of assets, property, or cash to disburse loan||No collateral required|
|Loan Type||Includes mortgages, home equity loans, auto loans, secured credit cards, and home equity lines of credit||Includes student loans, personal loans, and credit cards|
|Rates||Interest rates tend to be lower due to collateral||Interest rates tend to be higher since the lender is taking on more financial risk|
|Penalty for Default||Your property, assets, or money is seized to pay it off and your credit score will drop||Loan will likely go into collections, your credit score will plummet, and you could still be required to pay it back in full|
Pros and Cons of Secured Loans
Potentially lower interest rate
Some tax deductions allowed
Lower threshold to qualify
Could lose assets
Not as flexible for borrowing
- Potentially lower interest rate: Since secured loans are tied to an asset or property, interest rates tend to be lower since there is less financial risk on the lender’s side. Lenders are confident they will get their money back, whether in the form of monthly repayments from you or the sale of the property.
- Some tax deductions allowed: Some secured loans, like mortgages, let you deduct from your taxes the interest you paid (up to a certain amount). Most home equity loans also have this perk.
- Lower threshold to qualify: Since you’re putting up collateral, the barrier to qualify is lower. Instead of considering your credit score and history, it’s also taking into account what you’re using to secure the loan.
- Could lose assets: If you don’t make on-time payments every month, you could face losing your collateral, whether that’s your home or car.
- Not as flexible for borrowing: Some unsecured loans, like personal loans, let you spend your loan on whatever you wish. Specific secured loans are usually tied to the collateral you’re putting up. For instance, a mortgage is tied to your home. Your auto loan is tied to the vehicle you’re buying.
How to Get a Secured Loan
Secured loans can come from a few different places, including traditional banks, credit unions, and online lenders.
If you’re looking to take out a loan, look for lenders that specialize in the area you’re looking to borrow in. For instance, if you’re looking for a home loan, look for lenders that offer mortgages. Compare lenders and get prequalified to see which ones offer the lowest interest rates and best repayment terms.
Lenders can process most applications for secured loans within a few hours (such as car loans) but mortgage and home loan approvals may take a month or two to finalize. Funding amounts vary by the type of loan you’re getting.
Alternatives to Secured Loans
In most cases, secured-loan alternatives are going to be high-cost propositions. Payday loans offer fast funding borrowed against your next paycheck but your APR could reach around 400%.
Secured credit cards might catch your eye but they may not a great choice because they require a cash deposit to open your account. A different option is an unsecured credit card for bad credit. The interest rate might be higher than average, but the credit line could help you make ends meet. Just be sure to pay off your credit card balance each month to avoid paying interest.
- A secured loan is one that requires collateral such as property, assets, or cash.
- A few common types of secured loans include mortgages, home equity loans, and auto loans.
- If you don’t pay back your secured loan, the lender could seize the collateral you put up to get the funding. This could be your home or car, depending on the type of secured loan you have.
- Alternatives to secured loans include unsecured loans like personal loans, payday loans, and secured and unsecured credit cards.
- Make sure you know what the risks are when taking out a secured loan, and have a solid plan to pay it back.