May 12th, 2021 | Updated on June 3rd, 2021
A secured loan helps a borrower access cash or make a large purchase – including buying a new home or a new car without minimal qualification requirements compared to unsecured loans.
By putting up an asset as collateral, a borrower can get a loan at a low-interest rate. The lender also takes up the lesser risk with the loan because they can repossess the collateral upon default.
But what types of loans fall under ‘secured’? How different are they from other loans? This guide details everything you ought to know about them.
What’s a Secured Loan?
These are loans that have collateral. When you apply for it, the lender asks for an asset to secure your loan. The lender then places a lien on your asset until you repay the loan in full. In case of a default, the lender can seize the collateral, sell it and use the proceeds to recover the outstanding loan balance.
Before taking a loan, always read the fine print to understand the promise and what’s on the line.
Types of Secured Loans
With collateral, lenders know their loan risk is covered in the worst-case scenario. Though this doesn’t guarantee loan repayment, it means they’ll get their money back. Some types include:
- Mortgage: with these loan types, your property or home acts as collateral. If you default on payments, the lender sells your home.
- Home equity line of credit (HELOC) – this loan affords you access to your home equity through a credit line. Through a HELOC, you can have your home as collateral.
- Car loans: when you take a loan to purchase a car, the vehicle you buy acts as collateral. If you default, the lender seizes the car.
- Land loans: land loans are used to purchase land. The land bought is used as collateral for the loan.
- Business loan: you can use a business loan to pay wages, purchase equipment, or invest cash in your projects. For a business loan, several things are used as collateral. For instance, land, building, or inventory can be used as security.
Assets used as Collateral
Almost anything of value can be used as collateral provided the law allows it. However, lenders prefer assets they can quickly sell and recoup their money. Some collateral items include:
- Real estate
- Cash accounts 9though retirement accounts don’t count)
- Collectibles and valuables
Unsecured vs. Secured Loan
A personal loan can either be secured or unsecured, depending on your lender. Consider former if you don’t qualify for an unsecured loan or qualify for the lowest interest rate.
When choosing between the two, consider the following difference:
- Credit score: with both, your score determines your eligibility.
- Interest rates: it’s often lower in secured loans.
- Penalties: with secured loans, the collateral is seized, but in unsecured loans, the balance goes into collections. In both options, defaulting leads to a drop in credit score.
- Loan type: secured loan types include auto loans, HELOCs, mortgages, secured credit cards, and business cards. On the other hand, unsecured loan types include personal loans, student loans, and credit card loans.
Steps to Getting a Secured Loan
When getting a loan, consider the following:
- Your credit score: before applying for the loan, check your credit score. Whether your loan gets approved or not depends on your creditworthiness. And though most loans don’t have strict credit requirements, it’s still important to have this information. You can get your credit report for free every year from the top credit Bureaus.
- Know the value of your assets: the value of the assets you intend to use as collateral will determine the loan amount you get. Research the asset’s value or get an appraisal before choosing a lender.
- Shop for a suitable lender: researching lenders gives you a chance to compare different fees and rates. In addition, most lenders offer prequalification requirements, which give insight into whether you are eligible for the loan or not. We recommend that you get prequalified by three lenders.
- Apply with the best lender: the lender you choose should have the best rates and terms. Most lenders accept online applications. However, for credit unions and banks, the application is often physical.
What Happens When You Can Repay the Loan?
When you miss several loan payments, the lender might repossess the asset used as collateral. Usually, the lender doesn’t have to give you repossession notice. Even worse, if the sale of your asset doesn’t recoup the loan balance, the lender comes back to you for the difference.
For instance, if a car loan balance is £28,000 when you default, and the car sells for £18,000, you’ll owe the bank £10,000. Also, details of the repossession remain on your credit report for six years.
If you default on a home equity loan or a business loan, the lender has to follow a lengthier process to recover the balance. They first have to go to court to get a foreclosure order on your home. But even then, it’s a good idea if you call your lender prior to missing payments to negotiate on loan modifications. This way, you get to keep your business or home.
If you need a loan, you should do your research and make lender comparisons. It’s also crucial to have a plan to repay the loan in full to avoid asset loss.