A secured personal loan is a loan you get by pledging something you own in exchange for money that you borrow from a lender. The item you commit to receiving the loan is the collateral.
The collateral, which can be a house, car, boat, savings account, or stocks, can be collected by the lender if you fail to repay the loan. Once you pay the loan off, the lender no longer has the right to take the collateral from you.
The lender also places a lien on the property with a secured loan. The lien indicates that should you sell the property, the lender is entitled to get money to pay off the remaining loan balance before you receive any money from the sale.
Unlike some other installment loans that use the item you’re purchasing as collateral (a house for a mortgage or a car for an auto loan,) the collateral you pledge on a secured personal loan is already yours. A secured loan can secure funding when your credit score does not qualify for an unsecured loan.
How does a secured loan work
Secured loans work when an asset, such as property or a car, becomes security for the loan repayment. If the loan is not repaid, you could lose that asset to the lender.
Secured loans are secured against a home, using the equity you’ve built up, or a car, as security. Secured loans may enable you to get the finances you may need.
A secured loan provides a lender with greater security if a borrower cannot meet the monthly repayments. That’s due to the asset acting as security for the loan.
- Secured loans are usually available to fund large-scale borrowing, including mortgage lending to purchase a property.
- The amount you can borrow, the length of the loan, and the interest rate will depend on your credit situation.
- An asset to act as security can be any item of value, such as a house, car, jewelry, or business stock. It may be what the loan is funding.
- Failure to repay the loan may result in losing that asset in repossession by the lender.
The lender has less risk involved because the collateral guarantees the loan, so secured loan interest rates tend to be lower than unsecured loans.
Types of secured loans
Mortgages and auto loans are perhaps the most well-known secured loans, but several other financing options may require collateral. These are the most common types of secured loans.
- Mortgages are a common type of loan used to finance the purchase of a home or other real estate. These loans are secured by the financed property, meaning the lender can foreclose if the borrower defaults.
- Home equity loans are collateralized by the borrower’s home equity. With a home equity loan, the borrower receives a lump sum of cash, on which interest begins accruing immediately.
- Auto Loans are secured by the vehicle being financed. A lender holds title to the financed vehicle until the loan is repaid in full to protect its interest in the collateral.
- Secured personal loans let borrowers access cash that can be used for personal expenses like home improvements, vacation costs, and medical expenses.
Type of collateral for secured loans
There are multiple types of collateral lenders will accept for a secured loan. Here are the most commonly accepted forms of collateral lenders accept:
- A home or real estate property is one of the most common forms of collateral for secured loans.
- Another common form of secured loan collateral is a car or other vehicle. The vehicle’s value secures most auto loans used to purchase a car.
- Loans that use investments as collateral are often called securities-based or stock-based loans. These are offered by investment brokerages or private banks to clients who already have investments with these companies.
- Some banks will also offer savings-secured or certificate-secured loans. Banks and credit unions typically provide these to existing customers.
Secured vs. unsecured loans
Qualifying for the loans
- Secured personal loans can be easier to qualify for than unsecured loans. A lender considers your credit score, history, income, and debts, but adding a savings account or vehicle to the application to secure the loan can give lenders more confidence to lend to you.
- Borrowers with good and excellent credit (690 or higher FICO) usually have the best chance of qualifying for an unsecured loan. Lenders review your credit score, history, and debt to income ratio to decide whether you are eligible. Some lenders review alternative data like your college education and where you live, too.
- Secured loans typically have lower rates than unsecured loans. Lenders decide your rate using the same factors they use when qualifying you, so the value of your collateral can affect your rate.
- Unsecured loans have fixed rates that typically range from 6% to 36%. The lowest rates usually go to the most qualified borrowers, while borrowers with fair to poor credit scores will get higher rates.
- Secured loans include auto loans, mortgages, home equity lines of credit (HELOCs), secured credit cards, and secured personal loans.
- Unsecured loans include unsecured credit cards, personal loans, and student loans.
There are a couple of factors that go into deciding if a secured or unsecured loan is best for your situation. A secured loan usually is easier to get, as the lender has less risk. For example, if you have a poor credit history or you’re rebuilding your credit, lenders will be more likely to consider you for a secured loan vs. an unsecured loan.
What happens if you default on a secured loan?
A secured loan is tied to a property or asset you own, so if you fail to maintain your contractual loan repayments, your account could default, and the asset you used as collateral could be at risk of repossession. However, this is usually a last resort, and there are ways to prevent this from happening.
Defaulting on a secured loan also has a negative impact on your credit score, which makes it harder to borrow money in the future.
Understanding the process is essential because there are set processes that lenders have to follow before they can take court action, as set out by the Truth in Lending Act. Follow the link to learn about those processes and your rights as a consumer.
How to deal with secured loan arrears
If you have missed a payment or cannot make one:
- Contact your lender and make the payment as soon as possible.
- If you cannot afford the payment, create a budget to see if there are any areas where you could save money to put towards your loan.
- Speak to your lender to ask if there is anything they can do to help. For example, they might offer you a payment extension, deferred payment, a reduced payment plan, or waiver of late payment charges.
If you have missed several payments:
- Catch up with payment arrears as soon as possible.
- Consider contacting a debt organization that can give you free debt advice or deal with your creditors on your behalf.
- Stay in contact with your lender.
Once you have missed payments, your lender will send you a notice of the arrears and a default notice. Once this happens, they will report to the credit agency, and your credit report will reflect the missed or late payments. It can be stressful but keep in contact with your lender, and they will be more willing to work with you if you are honest and attempting to pay.
Secured loans are a great option if you are rebuilding your credit or looking for a loan with the best possible rates. Secured loans may offer larger loan amounts, so you can access additional funding if needed. As with any loan, make sure to shop lenders and available products. Entering the situation-aware of your credit score and needs will make the process less stressful.