A secured loan is one backed by collateral, which is property your lender can seize in the event you are unable to pay for the loan. For lenders, it provides assurance the loan will be covered no matter your ability to repay the loan. Because of that lower risk, lenders may be willing to offer borrowers lower rates than they would on unsecured loans, or offer loans to borrowers who might not qualify for a loan without collateral.
There are two kinds of secured loans: loans used to purchase the property that serves as collateral and loans where you can choose how to use the funds.
Secured loans used to purchase items used for collateral
The most common examples of this kind of secured loan are mortgages and auto loans. With a mortgage, the home you purchase secures the loan you need to buy it. Similarly, a car you purchase with an auto loan acts as collateral for the loan.
Secured loans that can be used for nearly anything
For secured loans you want to use for an influx of cash, you must provide collateral in the form of a liquid asset, like a savings account, or property. For example, once you have a car or home, you could use the property and your equity in it as collateral for a secured loan, giving you access to funds you can use for a number of things.
Many people use secured loans like home equity loans to consolidate debt or make home improvements, but other common uses include building credit, financing large purchases or covering emergency expenses.
Collateral you can use for a secured loan
The collateral you can use depends on the loan, but generally speaking, you can get a secured loan using collateral like a car or home you own, or equity in either. You could also get a secured loan using a certificate of deposit or savings as collateral.
Anything the lender is willing to accept can be used for collateral, though in most instances property where ownership is traceable, says Christel Ventura, assistant vice president of GTE Financial, a credit union in Tampa, Fla. For example, a title is more likely to be accepted than other property such as a Jet Ski.
When to consider a secured loan
With store financing, credit cards and short-term payday loans available, you may be wondering why a secured loan would be a better option. There are several reasons. First, a secured loan could provide more favorable loan terms. Second, people with lower credit scores may have an easier time qualifying for secured credit than unsecured credit.
Because property or savings secures the loan, a lender may offer you a better APR than they would if the loan were unsecured. On the other hand, if you’re concerned your credit score might prevent you from qualifying for a loan you need, a secured loan could solve that problem. A lender takes on less risk when issuing a secured loan than an unsecured loan, so for borrowers with shaky credit, collateral could be the difference between loan approval and denial. However, a better credit score will likely improve your chances of approval and help you get a better rate, no matter the loan type.
Overall, rates and terms vary greatly by lender, which is why it’s important to shop around for the best rate.
Kinds of secured loans
When you buy a home with a mortgage, the property you purchase secures the loan. If you fail to make your mortgage payments, the bank can start the foreclosure process, which can end with the bank repossessing your property to recoup its losses on your unpaid mortgage. Your home also serves as collateral in a refinance mortgage or a cash-out refinance.
Home equity loan or home equity line of credit (HEL/HELOC)
You can use the equity you’ve built in your home to take out a home equity loan or a home equity line of credit. In both cases, if you fail to make your payments, you risk losing your property and your equity in it.
When getting a secured loan using the equity in your home, you will need to have the home’s value assessed.
“If the secured loan total is less than $250,000, then the house will be appraised using an automated valuation system,” according to Stephen Adamo, U.S. head of home loans for Santander Bank. However, if the loan you’re seeking is greater than $250,000, an appraiser comes to the property to assess its value and ensure you have the appropriate equity to act as collateral for the loan.
When you purchase a vehicle with an auto loan, the car will act as collateral. Your lender may repossess the vehicle if you miss payments on your auto loan.
You can use your vehicle as collateral for other secured loans, as well. A title loan (sometimes called a title pawn, title pledge or pink slip loan) allows vehicle owners to get a short-term, fast-cash loan that they can use however they like, but these loans pose great risks to the borrower, the Federal Trade Commission warns. Title loan terms generally range from 15 to 30 days for a few hundred or thousand dollars, at very high interest rates. The loans also carry hefty fees. You retain possession of your car during the loan term and get the title back upon full repayment, but if you can’t repay your loan, the lender can take your car, the FTC warns.
Secured personal loans
Some banks and credit unions offer secured personal loans, meaning you can get a loan to purchase nearly anything if you put up a cash deposit, certificate of deposit (CD) or savings account as collateral. While you can use a secured personal loan to finance a large purchase or consolidate debt, you may also want to use a secured loan to build or rehabilitate your credit score by consistently making on-time payments.
When you use cash or savings, the lender places a hold on the account for the principal balance of the loan. Depending on the lender, you may get gradual access to your collateral as you pay off the loan, or your collateral will remain unavailable until you’ve paid the loan in full. Of course, if you don’t pay your loan as agreed, the lender can take your collateral.
Secured personal loans may be easier to qualify for than unsecured loans, but they’re far from a sure thing. Lenders may not issue the loan if they see what they consider to be red flags.
Pawnbrokers offer small-dollar, short-term loans in exchange for a variety of collateral. Borrowers leave possessions with pawn shops to secure loans of $150 on average, according to the National Pawnbrokers Association. If borrowers don’t repay their loan, the pawn shop may sell the collateral to cover the cost of the loan, though in some states, borrowers can pay to renew these loans. Interest-rate caps vary by state, but in general, these loans can be very expensive.
What can you use secured loans for?
In the case of a purchase mortgage or auto loan, you don’t have a choice: You use the loan to buy a home or a vehicle, and you can’t borrow more than the value of the property.
With other secured loans, such as secured personal loans, home equity loans and cash-out refinances, you can use the cash for whatever you want, though the lender may deny your loan application if they see what they consider to be red flags.
“If a person is trying to take money out of their home to fund a business, that is typically not allowed,” said Christel Ventura, assistant vice president of GTE Financial, a credit union in Tampa, Fla. Another red flag could be, “if they are borrowing money to buy stocks, bonds or cryptocurrency.”
It really depends on the lender. Adamo said, “There are no limits on what the money can be used for.” This includes funding a business or using the money for investments. He says common uses for home equity loans or HELOCs include making home improvements, covering education expenses, buying a car or acting as a rainy day fund.
Where can I get a secured loan?
You can get a secured loan from banks, credit unions or other non-bank lenders which you can usually find online. Compare products from all sorts of lenders to make sure you’re getting the best rate, but also consider your personal preferences when choosing a lender.
For example, if you already have an account at a bank or credit union that offers secured loans, it may be easier to put up collateral. And if you prefer in-person interactions with your financial institution, you may want to prioritize working with a bank or credit union with a branch near you. On the flip side, if you like to do everything digitally, an online-only lender might be a better fit, though good digital experiences are not exclusive to online-only shops.
Secured loans and their risks
Like any loan, secured loans are not without risk. In the worst-case scenario, you could default on the loan, have the collateral seized and not have it cover the entire amount owed. Meaning you may not only take a hit on your credit report, but you are without the collateral you put up and you still owe money.
That being said, default doesn’t happen right away, and lenders may work with you to get you back on track to pay off the loan. So if you are struggling with repayment, reach out to your lender.
Set yourself up for success
Before taking out a loan, you need to consider a few things.
How much do you need? This amount may be different from how much you may be qualified to borrow.
What kind of monthly payment can you afford? Not only do you need to consider how much money you need, you need to look at your budget and see how much you can reasonably expect to pay each month. If you can’t make the payments, you can’t afford the loan.
What’s your credit like? Before looking for loans, also be sure to check your credit report and credit score so you can address any issues that may be lowering your credit score and impacting the rates offered to you. Things you can do to help your credit in the short term include, disputing inaccurate information on your credit reports, making payments on time and paying down debt.
Can you get a better deal? Interest rates vary significantly based on your financial situation and by lender, so be sure to shop around to ensure you get the best rate for your loan.
Who can benefit from a secured loan?
People with less-than-perfect credit scores, someone wanting to purchase a home or vehicle without paying cash and consumers looking for low loan rates could benefit from a secured loan.
When you have a low credit score
If you don’t have a stellar credit score, you may not be able to qualify for an unsecured loan, making a secured loan your only option.The most obvious benefit of a secured loan in this instance is the ability to get the loan.
Having a secured loan could also help you to repair your credit so long as you pay the loan on time and don’t miss any payments.
When a secured loan is the only option
A secured loan is the only option when taking out a mortgage. It allows you to purchase your home while living there during loan repayment. A mortgage payment on a home could be less than paying rent elsewhere, saving you money.
And if you don’t have the cash to buy a car, an auto loan gives you access to the transportation you need while spreading out your payments over several years.
When you want a low rate
While lenders consider your credit score and other factors when determining loan rates and terms, the fact that you put up collateral means you’ve got some skin in the game and pose less of a risk to the lender. That may translate into lower rates than what you could get on an unsecured loan. (For example, HEL rates are generally lower than personal loan rates.)
Alternatives to secured loans
If you’re not interested in putting up collateral to get a loan or can’t find a secured loan that meets your needs, you may have other options.
Unsecured personal loans
Even borrowers with bad credit may qualify for an unsecured personal loan, though you can expect the interest rates to be relatively high. If you have good credit, you may qualify for a personal loan with a single-digit APR. Compared with a home equity loan, a personal loan rate may be higher, but the application process will likely be much faster. You can compare personal loan rates right here on LendingTree.
Borrow from family, friends or your community
If you’re in a short-term jam, asking someone for help might be your best solution. Short-term products like payday loans, pawn loans and title loans can cost a lot and lead to a costly cycle of debt, according to research from the Pew Charitable Trusts.
Payday loans are small-dollar, very short-term loans that help you make ends meet until your next paycheck. The terms is typically two weeks, or the amount of time between paychecks. These loans usually have high interest rates but require very little for you to be approved. Though they can have high fees and triple-digit APRs, some borrowers see this as their only, and therefore best option, according to the Pew research.