What Is a Secured Loan?
A secured loan is a form of debt that requires collateral. This type of loan is common for large purchases, like homes and cars. It also provides an option for those with bad credit to access financing as long as they can provide valuable collateral.
Here’s what you need to know about a secured loan, its benefits and drawbacks and how you can secure debt.
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What’s a secured loan?
Secured loans are debts that are backed by a valuable asset, also known as collateral. This asset can take the form of a savings account or property, like cars or houses. They can make it easier for those with bad credit to take out debt and access lower rates.
Secured loans are also known as collateral loans, and the collateral you provide for a secured loan offsets some of the risk lenders take on when lending you money. If you’re unable to repay the debt, your lender can seize your collateral to recoup their financial losses.
As a result, your bank, credit union or online lender may have requirements around what type of collateral you can use. Some lenders may only accept a savings account or certificates of deposit (CDs). Others may require your vehicle and have specifications around that as well, such as age and mileage.
Secured loan vs. unsecured loan
The differences between secured and unsecured debt are simple but important. Unsecured loans don’t require collateral, so lenders rely more heavily on your credit history. This makes it difficult for consumers with bad credit scores to access these types of loans — and if they do qualify, they often get stuck with higher interest rates.
Generally, unsecured loans come with higher rates than secured loans because there’s no collateral for the lender to seize if the borrower defaults. These types of loans are best for those with good-to-excellent credit and can qualify for a lender’s best rates.
Types of secured loans
Secured loans come in many forms depending on your needs and what you’re willing to use as collateral. Keep in mind that each type of loan comes with risks, and you can lose your collateral if you are unable to keep up with payments.
- Auto loans: These are among the most common types of secured loans. Auto loans are backed by the vehicle you’re financing, though some lenders offer unsecured car loans.
- Auto title loan: A car title loan allows you to borrow against the value of your car, using your vehicle’s title as the collateral. However, this is a risky type of loan and it may be best to seek other types of credit.
- Home equity line of credit: A home equity line of credit (HELOC) allows homeowners to borrow against the equity they’ve built into their home. It works similar to a credit card and your home acts as collateral.
- Home equity loan: This is sometimes referred to as a second mortgage. As the name suggests, a home equity loan allows you to tap into your home’s equity; however, your home will be on the line for this type of debt.
- Mortgage: This is another common type of secured loan and allows consumers to finance the purchase of a new home. When it comes to mortgages, your home will serve as your collateral.
- Secured credit card: While most credit cards are unsecured, some companies also offer secured credit cards. These often require that you make an initial deposit which serves as your collateral.
- Secured line of credit: While this type of debt isn’t common, a secured personal line of credit (PLOC) works similar to a credit card, allowing you to borrow up to a predetermined amount. A PLOC may require a savings account or CD as collateral.
- Secured personal loan: While personal loans are typically unsecured, some lenders may also provide secured personal loans. The type of collateral you’ll need for this type of loan will depend on your lender.
- Pawn shop loan: This is another type of secured debt that may be best to avoid. Pawn shop loans are backed by a valuable item in exchange for a lump sum of money that comes with high fees.
What can be used as collateral for a loan?
Just as there are different types of secured loans, there are also various types of assets you can use to secure your debt. Some of the most common forms of collateral are real estate, vehicles, savings accounts and CDs.
- Real estate
- Checking and savings accounts
- Money market accounts
- Mutual funds
- Bond investments
- Insurance policies
- Jewelry and other expensive types of valuables
Pros and cons of a secured loan
Secured loans provide consumers a variety of benefits, including lower interest rates and access to credit if your score is less than perfect. However, they aren’t without their downsides that should be carefully considered.
Can access lower interest rates because collateral offsets lenders’ risk
Allows those with bad credit to access loans and revolving credit
Helps borrowers build credit as long as they make consistent, on-time payments
Borrowers may lose a valuable asset — such as home, vehicle or savings account — if they can’t repay
Lenders may place restrictions on the type of collateral that can be used
Underwriting process can take longer because the collateral will take time to approve
Secured loans for bad credit
Secured loans may be a good option if you have bad credit. Since the collateral you provide decreases the risk on the lender’s end, you may have an easier time qualifying for a loan without sky-high interest rates. To get a loan with bad credit, you’ll need to make sure you can provide a valuable asset that you won’t mind losing should things not pan out.
How to apply for a secured loan
Each lender has its own unique process, but here’s what you may come across when you apply for a secured loan.
Check your credit score
Before applying for a secured loan, check your credit score. This can give you an idea of what rates, terms and amounts you may qualify for, as well as how lenders may view your application.
If you have a good or excellent credit score, you may want to consider an unsecured loan to avoid losing your assets in case you’re not able to fully repay the loan. But if your credit is bad, you may want to improve your credit score before applying for a loan.
Evaluate the value of your collateral
Typically, the value of your collateral will determine how much you can borrow. The type of collateral you have can also limit what lenders you may be able to work with, as they will typically have guidelines as to what assets they accept. Be sure to research any lenders you’re interested in to find out what collateral they require.
Shopping around and comparing lenders can help ensure you get the best rates, terms and amounts for your financial position.
In some cases, such as with auto loans and mortgages, with rate shopping, credit score companies will only count your inquiries as a single pull during a set period of time. For FICO, it’s 45 days, while for VantageScore, it’s only 14 days. This will allow you to compare lenders without multiple hits to your credit score as hard credit pulls can cause your score to drop.
Close on your loan
Once you make your final decision, you’ll need to close on your loan and sign your agreement. You’ll likely need to verify information like your residence, income and employment. Keep in mind that the underwriting process can take longer when it comes to getting a secured loan.