What is a Secured Loan?
A secured loan is a loan that requires the borrower to pledge collateral for the loan. For example, if a borrower needed $10,000 for a secured loan and had a car worth $10,000 or more, they could potentially use their car as collateral towards the loan. The borrower would then pay back the $10,000 with interest over the term of the loan.
More Information on Secured Loans
Going into more detail, a secured loan can be broken down into three main parts: The lender (or bank), the borrower, and the collateral. Secured loans can be obtained from many banks and financial institutions. Secured loans are less risky for the lender as the collateral can be seized if the borrower defaults.
Auto loans and mortgages are examples of secured loans. The reason for this is if you have an auto loan or a mortgage, and you stop paying your lender, they can seize your car or the home you have the mortgage on in order to get back the money that's owed to them.
Secured loans are beneficial to borrowers with less than outstanding credit as they are less risky to the lender, making a risky borrower more likely to get approved. Additionally, secured loans generally have lower interest rates, and borrowers may be able to get a higher loan, so long as they have the collateral to cover it and also meet other conditions.
What are different types of secured loans?
There are several different types of secured loans, including:
- Home mortgage
- Auto loan
- Home Equity Line of Credit (HELOC)
- Secured credit cards
- Bad credit loans
Some secured loans will require a cash deposit instead of a physical asset. For example, a secured credit card might have you deposit money equal to the credit limit of the secured credit card. That way, you can only spend up through how much you've deposited, and if you were unable to default on the credit card, the credit card company would have your money in their account already.
Differences Between a Secured Loan and an Unsecured Loan
A secured loan has collateral and generally has lower interest rates as the lender is at less risk if the borrower defaults. On the other hand, an unsecured loan has no collateral but generally has much higher interest rates as these types of loans are riskier for lenders. A credit card is a type of unsecured loan.
Secured loan example
Here is an example of a secured loan: Eric wants to buy a $25,000 car and has $5,000 available as a down payment. He puts $5,000 down on his car and takes out an auto loan, which is a secured loan, for $20,000 and purchases the car. Eric pays the auto loan for nine months but then stops paying. The bank that lent Eric $20,000 repossesses Eric's car because he defaulted on the loan, and the bank then sells the car to recoup some or all of their losses.
What Collateral Can Be Used for a Secured Loan?
Collateral can be anything of value that is owned by the borrower and can be used to pay back the loan. It can include any form of security such as real estate, stocks, bonds, or even a piece of jewelry. It can also be a cash deposit, such as with secured credit cards. The lender has the right to seize the collateral if the borrower defaults. Also of note, if the seized collateral does not fully cover the debt, the lender can demand payment of the rest of the loan.
What Happens if you Don't Pay back a secured loan?
If you have a secured loan and don't pay it back, the lender can and generally will seize the assets that you have put up for collateral. Additionally, chances are, your credit report will note that you defaulted on a secured loan and had collateral seized for up to seven years.
It's important to contact your lender if you are having difficulty paying back your secured loan. Many lenders will work with you to ensure that you pay them back if you communicate with them openly about your situation.
If you're still having trouble paying back your secured loan, it might make sense to slow payments on unsecured loans as those loans cannot seize assets from you if you fail to pay them. This is especially true if you're falling behind on your mortgage or auto loan payments.
Talk to a financial expert for further help as many companies exist to help people in financial distress. Be sure to do your research before hiring anyone.
Do secured loans help your credit score?
Taking out a secured loan and making regular on-time payments can help you build credit if you have a poor or no credit history. This will, in turn, help you raise your credit score.