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Secured loans can help borrowers access much-needed cash or make major purchases, such as a home or new car, often with less stringent qualification requirements than unsecured loans. By pledging valuable assets, a borrower can obtain financing while keeping interest rates low. Lenders also face less risk when making secured loans, as they can seize or repossess collateral if the borrower defaults.
What is a secured loan?
A secured loan is a loan secured – or secured – by something of value, such as real estate, cash accounts, or an automobile. In many cases, the loan is secured by the underlying asset financed such as a house or a vehicle; alternatively, borrowers may be able to pledge other collateral such as valuable investments or collectibles.
If a borrower defaults on a secured loan, the lender may repossess, seize or otherwise seize the asset to recover 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 vs Unsecured Loans
For example, in the case of secured or unsecured personal loans, a borrower with a high credit rating may qualify for an unsecured loan with a low interest rate without having to post collateral. Another applicant for the same unsecured loan might not qualify and have to rely on a secured option as it is more risky. One type of loan is not necessarily better than another, but it is important to understand your options before signing on the dotted line.
How Secured Loans Work
Secured loans allow borrowers access to a lump sum of cash to cover everything from home improvement projects to buying a car or house. You can usually get these loans from traditional banks, credit unions, online lenders, car dealerships, and mortgage lenders.
Even though secured loans are less risky for lenders, the application process usually requires a thorough credit check, although some lenders offer the option to prequalify with just a soft credit check. And, while secured loan balances earn interest like other loans, borrowers can access lower annual percentage rates (APRs) than 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 to improve the lender’s chances of recovering its funds.
What can be used as collateral on a secured loan?
Often the type of collateral required for a secured loan is tied to the underlying purpose of that loan. This is most famously exemplified by mortgages, where the home loan is secured by the financed home. That said, appropriate collateral may also depend on a number of other factors, including the lender and the loan amount. Common forms of collateral include:
- Real estate, including houses, commercial buildings, land and equity in real estate
- Bank accounts, including checking accounts, savings accounts, certificate of deposit (CD) accounts, 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 company assets
What happens if you default on a secured loan?
If you default on a secured loan, your lender can seize the collateral to recover the outstanding loan balance. In the case of a home loan, this involves filing a foreclosure action against the borrower. If you default on an auto loan, the lender can repossess the financed vehicle. In general, the value of the loan’s underlying collateral must meet or exceed the loan amount, which improves the lender’s chances of limiting its 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 may not be able to recoup the mortgage amount through a sale. forced. When the sale of collateral does not cover the entire outstanding balance of a loan, the lender may attempt to recover the remaining amount by filing a deficiency judgment.
If you have a secured loan and think you might default, there are steps you can take to limit the negative impact on your credit score. Contact your lender immediately, review your budget, and prioritize secured loan repayments so you don’t lose your home or other valuable collateral.
Types of secured loans
Mortgages and auto loans are perhaps the best 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 home or other real estate. These loans are secured by the financed property, which means that the lender can foreclose in case the borrower defaults.
- Home equity lines of credit. A home equity line of credit (HELOC) is a revolving loan that is secured by the borrower’s equity in their home. The borrower can use the funds according to his needs.
- Home equity loans. Like a HELOC, a home equity loan is secured by the equity in the borrower’s home. With a home equity loan, however, the borrower receives a lump sum cash payment, on which interest begins to accrue immediately.
- Car loans. Auto loans are secured by the financed vehicle. To protect its interest in the collateral, a lender holds title to the financed vehicle until the loan is paid in full.
- Secured personal loans. Secured personal loans give borrowers access to cash that can be used for personal expenses such as home improvements, vacation costs, 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 they pledge as a security deposit. This makes these cards a great option for borrowers trying to improve their credit scores.
How to get a secured loan
Secured loans are usually available from traditional banks and credit unions, as well as online lenders, car dealerships, 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 become familiar with your score, use the information to prequalify for a loan or take steps to improve your score and your chances of approval.
- Review your budget. If you’re considering a secured loan, it’s also worth reviewing your budget to determine what you can afford to pay each month. It is always important to consider existing debt repayments when taking out a new loan.
- Assess the value of potential collateral. When you’re ready to shop around for a loan, assess the value of your potential collateral, including cash account balances, home equity, and any other valuables, to see how much you can borrow.
- Shop around for the best loan. After evaluating your credit score and how much money you can afford to borrow, start researching lenders. If you’re considering a HELOC or home equity loan, contact your current lender to learn more about your options. If you’re considering applying for a secured personal loan, look for lenders that offer prequalification without a credit check.
- Submit an official request. Once you have prequalified with a lender, submit a formal application. Unlike the unsecured loan application process, lenders who offer secured loans will likely require 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 could 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 default on the loan, your collateral could be repossessed or seized on
- Borrowing is less flexible as permitted uses of loans are often tied to the collateral itself