A secured loan is a loan backed by collateral. Since you have to use one of your assets to secure the loan, secured loans are easier to obtain than unsecured loans. They can be an effective way to get the funds you need, but they come with risk.
Here is what you need to know about secured loans before you apply for them.
What is a secured loan and how does it work?
Secured loans are loans protected by collateral. This means that when you apply for a secured loan, the lender will want to know which of your assets you plan to use to secure the loan. The lender will then place a lien on that asset until the loan is repaid in full. If you don’t repay the loan, the lender can claim the collateral and sell it to recoup the loss.
It is important to know exactly what you are promising and what you stand to lose before taking out a secured loan.
Secured loan vs unsecured loan
Some loans, like personal loans, can be secured or unsecured, depending on the lender. If you do not qualify for the unsecured option or are looking for the lowest possible interest rate, check to see if the lender offers a secured option for the loan you are interested in.
When it comes to choosing a secured loan over an unsecured loan, several factors should be taken into account. Here are some of the differences between the two and some pros and cons of each type of loan:
|Secured loan||Unsecured loan|
|Credit score||Credit score and financial health will determine eligibility||Credit score and financial health will determine eligibility|
|Interest rate||Usually lower||Usually higher|
|Penalties||Collateral can be foreclosed, credit score will drop||Missed payments will go into collections, credit score will drop|
|Types of loans||Mortgages, HELOCs, auto loans, business credit cards and guarantees, etc.||Unsecured credit cards, student loans, personal loans, etc.|
Types of secured loans
Lenders want to know that they are leveraged once you walk away with their money. When they place a lien on your collateral, they know that in the worst-case scenario, they can take possession of the assets you are using as collateral. This does not guarantee that you will repay your loan, but it gives lenders a greater sense of security and gives the borrower more momentum to repay the loan.
Types of secured loans include:
- Mortgage: With a mortgage, you put your home or property as collateral to buy that home. If you are unable to make the payments, your home may be foreclosed.
- Home equity line of credit: A Home Equity Line of Credit (HELOC) gives you access to the equity in your home in the form of a line of credit, like a credit card. With a HELOC, you also put your house as collateral.
- Auto loans: When taking out a loan to pay for a car or any other vehicle, your vehicle will serve as a guarantee. If you don’t make payments on time and in full, your vehicle could be seized.
- Ready for the field: A land loan is used to finance the purchase of land. This type of loan uses the land itself as collateral.
- Commercial loan: Business loans can be used to purchase equipment, pay salaries, or invest in business projects. When you take out a business loan, there are a number of things you can use as collateral. For example, inventory, equipment, or your land or building can be used to get a business loan.
What types of collateral are used to support a secured loan?
Secured loans are usually the best – and often the only – way to get large sums of money. Almost anything can be accepted as collateral, as long as the law allows it. Lenders prefer assets that are easy to collect and can easily be turned into cash. What you use as collateral will likely depend on whether your loan is for personal or business use. Here are some examples of guarantees:
- Real estate, including the equity in your home.
- Cash accounts (retirement accounts are generally not eligible).
- Cars or other vehicles.
- Machinery and equipment.
- Insurance conditions.
- Valuable and collector’s items.
How to apply for a secured loan?
When it comes to getting a secured loan, follow these steps before you apply:
- Check your credit: Before you apply for a loan, you will want to check your credit report. Loan approval largely depends on your creditworthiness, and although secured loans may have less stringent credit requirements than unsecured loans, it is still important to know your credit score for qualification. You can check each of your credit reports for free every 12 months (or every week until April 20, 2022) with AnnualCreditReport.com.
- Check the value of your assets: The value of the asset you want to use as collateral will usually determine how much you can borrow with a secured loan, so get an appraisal or research the estimated resale value before looking for lenders.
- Take a tour of the different lenders: Shopping allows you to compare the rates and fees of lenders. Many lenders offer prequalification, so you can see what you qualify for without impacting your credit. It is usually best to be prequalified with at least three lenders.
- Apply for a loan from the most competitive lender: If you are applying to a lender online, the whole process can usually be done online. If you are applying to a bank or credit union, you may need to visit a physical location.
What happens if you default on a secured loan?
After a few missed payments on a secured loan, the lender is likely to repossess the asset used to secure the loan. In many states, the lender is not required to give you notice of repossession. To make matters worse, repossession is not the end of the story. If the repossessed asset does not sell enough to cover your loan amount, you are responsible for the difference.
For example, if you owe $ 20,000 when you stop paying a boat loan and the boat is repossessed and sold for $ 15,000, you owe the lender the $ 5,000 outstanding. The repossession stays on your credit report for seven years.
If you miss payments on a mortgage, home equity loan, or business loan, the lender has a longer process to get their money back. In about half of the states in the United States, a lender must go to court to foreclose on a property. In the other half, the lender is required to provide you with advance notice of foreclosure. Either way, it’s a good idea to call your lender as soon as you know you are missing payments to see if you can negotiate a loan modification that will keep your home or business.
If you are interested in a secured loan, the most important step you can take is to do the necessary research and compare lenders. It’s also important to have a plan in place to pay off your loan on time and in full to avoid losing your collateral.
Although secured loans carry more risk than unsecured loans, they can be useful tools as long as you maintain your monthly payments.