What Is a Secured Loan?

Secured Loans Explained

Two people shaking hands with various icons, including a hand waving, a hand doing thumbs down gesture, an envelope with money sticking out, and a bank-like structure, illustrating a headline that reads, "What do Know About Secured Loans," with text that reads, "including a good way to build credit, provided you go through a reputable lender (like a bank). Types of secured loans include mortgages and car loans. It’s important to carefully consider what you’ll use as collateral, and make sure you can make your payments. Generally intended for those who have been denied unsecured loans. Be careful not to overextend yourself—the plan might backfire."

The Balance / Bailey Mariner

Secured loans require property or assets to guarantee repayment. Not every loan needs collateral, but it’s required in some cases. Your collateral can be money or other property.

Definition and Example of a Secured Loan

A secured loan is one where the lender requires that you pledge collateral, such as a piece of real property, another asset, or money, to get funding. Examples of secured loans include:

  • Mortgages
  • Home equity loans
  • Car-title loans
  • Auto loans

You can find secured loans with just about any lender that provides loans to consumers. Most lenders offer traditional secured loans, such as mortgages and auto loans, but there are alternatives. Others offer secured loans where you can use your savings or CD account as collateral. 

Your collateral can come into play if you don’t make loan payments, and your account goes into default.

How a Secured Loan Works

Secured or not, loans allow you to borrow money to buy something now. You can then repay the money later, usually on a monthly basis.

Most secured loans require a credit check. Lenders will determine your interest rate based on your credit history and your credit score. Interest rates for secured loans tend to be lower than those for unsecured loans, because you’re using an asset to secure your loan.

You'll get the money if your loan is approved, but the lender will place a lien on your collateral. The lien gives the lender a legal right to repossess your property should you fall behind on payments and go into default on the loan. The lender can sell the asset it seizes to try to recoup the money you borrowed.  

This calculator can help you understand what your monthly payment will be so you can avoid offers that overextend your budget and could cause you to risk default:

Even if your lender resells your assets, the money from the sale might not cover the full amount you owe on the loan. The lender could pursue you in court for the remaining balance in that case.

Secured Loans vs. Unsecured Loans

Secured loans require collateral. Unsecured loans don’t require that you put up an asset to secure the loan. Lenders instead give out these 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 Types Include mortgages, home equity loans, auto loans, secured credit cards, and home equity lines of credit. Include student loans, personal loans, and credit cards.
Rates Interest rates tend to be lower due to collateral. Interest rates tend to be higher, because the lender is taking on more financial risk.
Penalty for Default Your property, assets, or money can be 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

Pros
  • Potentially lower interest rate

  • Some tax deductions allowed

  • Lower threshold to qualify

Cons
  • Could lose assets

  • Not as flexible for borrowing

Pros Explained

  • Potentially lower interest rate: Secured loans are tied to an asset or property so interest rates tend to be lower. There's less financial risk for the lender. It's confident it will be able to get its money back, whether in the form of monthly repayments from you or from the sale of the collateral.
  • Some tax deductions allowed: Some secured loans, like mortgages, let you deduct the interest you pay from your taxable income, subject to some restrictions. Some home equity loans offer this perk, depending on what you use the proceeds for.
  • Lower threshold to qualify: The barrier to qualify is lower because you're putting up collateral. The lender takes what you’re using to secure the loan into consideration rather than relying so heavily on your credit score and history.

Cons Explained

  • Could lose assets: You face losing your collateral if you don't make on-time payments every month.
  • Not as flexible for borrowing: Some unsecured loans, such as personal loans, let you spend your loan on whatever you like. Secured loans are usually tied to the collateral you’re putting up. A mortgage is tied to the home you buy with it. Your auto loan is tied to the vehicle you’re buying.

How To Get a Secured Loan

Secured loans can come from traditional banks, credit unions, and online lenders. Look for those that specialize in the area in which you're looking to buy. Look for a mortgage lender if you want to apply for a home loan. Compare lenders and get prequalified to find out which offer the lowest interest rates and best repayment terms.

Lenders can process applications for secured loans such as car loans within a few hours. But mortgage and home loan approvals can take a month or two to finalize. Funding amounts can vary by the type of loan you’re getting as well.

Alternatives to Secured Loans

Secured loan alternatives will be high-cost propositions in most cases. Payday loans offer fast funding that's borrowed against your next paycheck, but your annual percentage rate could be has high as 400%.

Secured credit cards might catch your eye, but they might not be a great choice, because they require a cash deposit to open your account. The cash is used to pay off your balance if you default. You might want to look for an unsecured credit card for bad credit instead, although the interest rate might be higher than average, but you can avoid paying interest if you pay off your credit card balance each month.

Key Takeaways

  • A secured loan is one that requires collateral, such as property, assets, or cash. 
  • Common types of secured loans include mortgages, home equity loans, and auto loans.
  • The lender could seize the collateral you put up if you don't pay back your secured loan. That could be your home or car, depending on the type of secured loan you've taken.
  • Alternatives to secured loans include unsecured loans like personal loans, payday loans, and secured credit cards.
  • Make sure you know what the risks are when you're taking out a secured loan, and that you have a solid plan to pay the money back.

Article Sources

  1. Wells Fargo. "How to Pay for Large Expenses."

  2. Cornell Law School Legal Information Institute. "Lien."

  3. Consumer Financial Protection Bureau. "What Is a Payday Loan?"