March 10, 2021

Secured Loan: What It Is, How It Works, & How To Get One

Kiah Treece READ TIME: 6 MIN.

Secured loans can help borrowers access much-needed cash or make large purchases – like a home or new car – often with less rigorous 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 extending secured loans, because they can foreclose on or repossess the collateral if the borrower defaults.

What Is a Secured Loan?

A secured loan is one that is collateralized – or secured – by a valuable asset, such as real estate, cash accounts or an automobile. In many cases, the loan is secured by the underlying asset being financed like a home or vehicle; alternatively, borrowers may be able to pledge other collateral like investments or valuable collectibles.

If a borrower defaults on a secured loan, the lender can repossess, foreclose on or otherwise seize the asset to recoup 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 vs unsecured personal loans, a borrower with a high credit score may qualify for an unsecured loan with a low interest rate without having to pledge any collateral. Another applicant for the same unsecured loan might not qualify and have to rely on a secured option because they present more risk. One type of loan isn't necessarily better than the other, but it's important to understand your options before signing on the dotted line.

How Secured Loans Work

Secured loans let borrowers access a lump sum of cash to cover everything from home improvement projects to the purchase of a car or home. You can typically get these loans from traditional banks, credit unions, online lenders, auto dealerships and mortgage lenders.

Even though secured loans are less risky for lenders, the application process generally requires a hard credit check – though some lenders offer the ability to prequalify with just a soft credit inquiry. And, while secured loan balances accrue interest like other loans, borrowers may access lower annual percentage rates (APRs) than are 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?

Oftentimes, the type of collateral required for a secured loan is related to the underlying purpose of that loan. This is most famously illustrated by mortgages, wherein the home loan is collateralized by the house being financed. That said, appropriate collateral can also depend on a number of other factors, including the lender and the loan amount. Common forms of collateral include:

  • Real estate, including homes, commercial buildings, land and equity in real estate
  • Bank accounts, including checking accounts, savings accounts, certificates of deposit accounts (CDs) 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 business assets

    What Happens If You Default on a Secured Loan?

    If you default on a secured loan, your lender can seize the collateral to recoup the outstanding balance on the loan. In the case of a mortgage, 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 underlying loan collateral should meet or exceed the loan amount – this improves the lender's chances of limiting their losses in the case of default.

    However, there are certain circumstances under which the loan balance can exceed the value of the collateral. For example, if you buy a home at the peak of the real estate market and then default on your mortgage during an economic downturn, the bank may not be able to recoup the mortgage amount through a foreclosure sale. Where the sale of the collateral doesn't cover the full outstanding balance of a loan, the lender can attempt to recover the remaining amount by filing for a deficiency judgment.

    If you have a secured loan and think you may default, there are steps you can take to limit negative impacts on your credit score. Contact your lender immediately, review your budget and prioritize secured loan payments so you don't lose your house or other valuable collateral.

    Types of Secured Loans

    Mortgages and auto loans are perhaps the most well-known secured loans, but there are a number of other financing options that may require collateral. These are the most common types of secured loans:

  • Mortgages. 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 in the case of borrower default.
  • 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 on an as-needed basis.
  • Home equity loans. Like a HELOC, a home equity loan is collateralized by the borrower's home equity. With a home equity loan, however, the borrower receives a lump sum of cash, on which interest begins accruing immediately.
  • Auto loans. Auto loans are secured by the vehicle being financed. To protect its interest in the collateral, a lender holds title to the financed vehicle until the loan is repaid in full.
  • Secured personal loans. Secured personal loans let borrowers access cash that can be used for personal expenses like home improvements, vacation costs and medical expenses.
  • Secured credit cards. With a secured credit card, a borrower gets access to a line of credit equal to the amount of cash she commits as a security deposit. This makes these cards an excellent option for borrowers trying to improve their credit scores.

    How to Get a Secured Loan

    Secured loans are typically available through traditional banks and credit unions, as well as online lenders, auto dealerships and mortgage lenders. Follow these five steps to get a secured loan:

  • Check your credit score. Before applying for any loan, check your credit score using a free online service or your credit card provider. Once you familiarize yourself with your score, use the information to prequalify for a loan, or take steps to improve your score – and your approval chances.
  • Review your budget. If you're considering a secured loan, it's also helpful to review your budget to determine what you can afford to pay each month. It's always important to consider existing debt payments when taking on a new loan.
  • Evaluate the value of potential collateral. When you're ready to shop for a loan, evaluate the value of your potential collateral–including cash account balances, home equity and any other valuable possessions – 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 planning to apply for a secured personal loan, look for lenders that offer prequalification without a hard credit check.
  • Submit a formal application. Once you prequalify with a lender, submit a formal application. Unlike the application process for an unsecured loan, lenders that offer secured loans will likely require an appraisal to confirm the value of your collateral before extending the loan.

    Pros 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 because secured loans pose less risk to lenders
  • Borrowers can take advantage of tax deductions for interest payments on some secured loans, such as mortgages

    Cons of Secured Loans

  • If you default on the loan, your collateral could be repossessed or foreclosed on
  • Borrowing is less flexible because permissible loan uses are often tied to the collateral itself

    by Kiah Treece

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