What Is Secured Loan?- How It Works, And Types

What is a secured loan?

A secured loan is a loan backed by collateral financial assets you own, like a home or a car, that can be used as payment to the lender if you don’t pay back the loan.

A secured loan is a loan that is backed by collateral. Because you must use one of your assets to secure the loan, secured loans are easier to qualify for than unsecured loans. They can be an effective way to get the funds you need, but they do come with risks.

Secured loans are loans that are 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 back the loan. The lender will then place a lien on that asset until the loan is repaid in full. If you default on the loan, the lender can claim the collateral and sell it to recoup the loss.

It is important to know precisely what you are promising and what you stand to lose before you take out a secured loan. Here’s what you need to know about secured loans before applying for one.

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.

A secured loan is a loan backed by collateral financial assets you own, like a home or a car, that can be used as payment to the lender if you don't pay back the loan.

Types of Secured Loans

Secured loans can be used for a number of different purposes. For example, if you’re borrowing money for personal uses, secured loan options can include:

  1. Vehicle loans
  2. Mortgage loans
  3. Share-secured or savings-secured Loans
  4. Secured credit cards
  5. Secured lines of credit
  6. Car title loans
  7. Pawnshop loans
  8. Life insurance loans
  9. Bad credit loans

As mentioned, vehicle loans and mortgage loans are secured by their respective assets. Share-secured or savings-secured loans work a little differently. These loans are secured by amounts you have saved in a savings account or certificate of deposit (CD) account at a credit union or bank. This type of secured loan can be useful for building credit if you’re unable to get approved for other types of loans or credit cards.

In the case of a secured credit card or line of credit, the collateral you offer may not be a physical asset. Instead, the credit card company or lender may ask for a cash deposit to hold as collateral. A secured credit card, for instance, may require a cash deposit of a few hundred dollars to open. This cash deposit then doubles your credit limit.

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Tip: In some cases, a credit card company may convert your account to an unsecured card after you have made a certain number of consecutive monthly payments on time.

Regardless of what kind of personal loan you’re considering, it’s often wise to first use a personal loan calculator to find the right monthly payment amount, term length, and interest rate to suit your needs.

Business Loans

Business loans can also be secured, though unsecured ones can be had. An equipment loan, for instance, is a type of secured business loan. Say your own construction business and need to purchase a new dump truck. You could use an equipment loan, secured by the dump truck you plan to purchase, to pay for it. As long as you pay the loan on time, you wouldn’t be at risk of losing the equipment you purchased.

One thing to note about secured business loans is that you may also be required to sign a personal guarantee. This means that you agree to be personally liable for any debts taken out by your business if the business defaults on the loan. So, if your business runs into cash flow issues, for example, you could be personally sued for a defaulted loan.

Car Title Loans and Pawnshop Loans

Other types of secured loans include car title loans and pawnshop loans. Car title loans allow you to borrow money using your car title as collateral. Pawnshop loans can use anything from tools to jewelry to video game consoles as collateral, depending on what you’re willing to pawn. These are generally short-term loans that allow you to borrow small amounts of money.

Note: Car title loans and pawnshop loans can carry interest rates that are well above average compared with other types of secured loans, and if you fail to repay them, you could lose your car or your personal assets held in pawn.

Life Insurance Loans

A life insurance loan lets you borrow money against a life insurance policy using its cash value as collateral. You could then repay the loan during your lifetime or allow the loan amount to be deducted from the death benefit paid to your beneficiaries when you pass away.

This type of loan is available with permanent life insurance policies, such as variable or whole life insurance.

Bad Credit Loans

Bad credit personal loans are another category of secured loans. These are personal loans that are designed for people with poor credit history.

Lenders can offer bad credit personal loans, but they may require some type of cash security, similar to share-secured loans, secured credit cards, and secured lines of credit. Note that a lower credit score can translate to a higher interest rate and/or fees with a bad credit secured loan.

What types of collateral are used to back a secured loan?

Secured loans are usually the best way and often the only way to obtain large amounts of money. Nearly anything can be accepted as collateral, as long as it is allowed by law. Lenders prefer assets that are easy to collect and can be readily turned into cash. What you use as collateral likely will depend on whether your loan is for personal or business use.

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Examples of collateral include:

  • Real estate, including equity in your home.
  • Cash accounts (retirement accounts typically do not qualify).
  • Cars or other vehicles.
  • Machinery and equipment.
  • Investments.
  • Insurance policies.
  • Valuables and collectibles.

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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

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 the repossession. To make matters worse, repossession is not the end of the matter. If the repossessed asset does not sell for enough to cover the amount of your loan, you are responsible for the difference.

For example, if you owe $20,000 when you stop making payments on a boat loan and the boat is repossessed and sold for $15,000, you will owe the lender the outstanding $5,000. The repossession stays on your credit report for seven years.

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If you miss payments on a mortgage, home equity loan, or business loan, the lender has a lengthier process to recoup its money. In about half of the states in the U.S., 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. In either case, it is a good idea to call your lender as soon as you know that you will be missing payments to see if you can negotiate a loan modification that will allow you to keep your home or business.

If you get a secured loan and are drifting into non-payment territory, take these steps immediately:

1. Get in Touch with the Secured Loan Lender

Communication is key if you fall behind on a secure loan payment. Lenders will like likely be more lenient in giving you more time to pay the loan, or even to work out new loan repayments if you’re upfront with them over late payments and income issues.

If a lender doesn’t hear from you, especially after sending you multiple notices, they may assume the worst, and start the loan repossession process That’s why it’s so important to reach out to your lender and let them know you’re having a secure loan repayment problem.

2. Prioritize Your Payments

Keeping your eyes on the prize and saving your home, car or other assets you put up for secured loan collateral should be a priority. If you do fall behind on a secured loan payment, like a home mortgage, pull back on other unsecured loan payments and use the cash to stay current on your secure loan.

Or, borrow cash from a family member or friend if your income problems are temporary, and use the money to pay back your secured loan and keep your home car, or other collateralized assets safe from repossession.

3. Get Financial Help

If you’re behind on your secured loan payments and struggling in other financial areas, as well, get professional money management help. Talk to a financial advisor, who can help in building your credit score, and getting you back on your feet, financially.

Next steps

If you’re interested in a secured loan, the most important step you can take is to do the research necessary and compare lenders. It’s also important to have a plan in place to pay your loan off in time and in full to avoid losing your collateral.

While secured loans do present more risks than unsecured loans, they can be helpful tools as long as you maintain your monthly payments.