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.
The idea behind a secured loan is a basic one. Lenders accept collateral against a secured loan to incentivize borrowers to repay the loan on time. After all, the prospect of losing your home or car is a powerful motivator to pay back the loan, and avoid repossession or foreclosure.
When you apply for a secured loan, the lender will ask which type of collateral you'll put up to "back" the loan. If you have trouble paying the loan, the lender can put a lien on the collateral (a lien is the legal term for the lender's claim to the borrower's collateral.)
The lender can keep the lien active until the loan is fully paid. At that point, the lien is lifted, and the collateral ownership reverts back to the borrower. In the event the borrower defaults on a secured loan, the lender can retrieve the secured loan collateral and sell it to cover any losses incurred on the loan.
That's why it's imperative for secured loan borrowers to understand what asset they're using as loan collateral, and to weigh the value of that asset against a possible lien or collateral loss if the secured loan falls into default.
Types of Secured Loans
Secured loans come in multiple forms, but the three most common types of secured loans include three financial consumer loan mainstays, all requiring appropriate collateral before the loan is approved.
- Mortgage Loans: Mortgage loans are at the top of the list of secured loans. Such loans are deemed "securable" by lenders because the borrower puts his or her house up as collateral. If the borrower doesn't pay back the secured loan, the home can go into foreclosure and the borrower can lose the home.
- Vehicle Loans: Loans for autos, boats, motorcycles and even private airplanes are considered secured loans, as the vehicles are used as collateral in securing the loan. Just like with a mortgage, failure to repay the secured loan can result in the vehicle being repossessed by the lender.
- Secured Credit Cards: For consumers with no credit history, secured credit cards are a good way to get credit and build up your credit scores. Yet unlike a mortgage or vehicle secured loan, secured credit cards require a cash deposit as collateral. If the card user doesn't pay the monthly bill, the cash deposit can be withdrawn from the card user's account, and applied toward the bill.
What Types of Collateral Can be Used to Back a Secured Loan?
Any asset allowed by law can be used to obtain a secured loan, although lenders will seek collateral that is liquid (i.e., easily sold for cash) and has a value roughly equal to the secured loan amount being borrowed.
Typically, secured loan collateral comes in the following forms:
- Real estate, including any financial equity earned since purchasing the residence
- Bank accounts, including checking accounts, savings accounts, certificates of deposit accounts, and money market accounts
- Cars, trucks, SUVs, motorcycles, boats, or other vehicles
- Stocks, mutual funds, or bond investments
- Insurance policies, including life insurance
- Precious metals, high-end collectibles, and other valuables
Secured vs. Unsecured Loans
Secured loan borrowers should weigh the value of obtaining a secured loan or an unsecured loan.
While a secured loan means a borrower will have to put up valuable collateral to obtain the loan, an unsecured loan isn't backed by any collateral. If you are late paying an unsecured loan or default on the loan, the lender has no right to any of your property or assets. Credit cards, student loans and personal loans are among the most common forms of unsecured loans.
Secured loans have several advantages over unsecured loans:
- Because you're putting collateral down, a secured loan is easier to obtain than an unsecured loan.
- Since lenders absorb less risk with secured loans, borrowers with weaker credit scores also find it easier to get a secured loan.
- Secured loans tend to offer lower interest rates than unsecured loans, making secured loans a good choice for borrowers on a tight budget.
- Secured loans also typically allow borrowers to get a bigger loan amount than with an unsecured loan, giving the secured loan borrower expanded financial options, although with more financial risk in the form of potentially lower secured loan repayment periods.
On the downside, getting a secured loan usually means less time to pay back the loan (as lenders would rather have the payment, plus interest, rather than the borrower's collateral assets.) In addition, given the complexities of properly valuing a borrower's collateral, the approval process for getting a secured loan normally takes longer than with an unsecured loan, where a response often comes in a day or two.
If the Borrower Defaults When Getting a Secured Loan
There's also a big downside to defaulting on a secure loan. When that happens, the assets you put up for collateral when getting a secured loan can be repossessed immediately. In many U.S. states, lenders aren't compelled to notify borrowers that their collateral assets have been seized and sold off to a buyer.
That's not all. If the repossessed collateral asset doesn't sell for the total price of the money owed on the secured loan, the lender can demand payment on the remainder of the amount owed from the buyer. In most instances, the lender's repossession of collateral assets can remain on a borrower's credit report for up to seven years.
To avoid defaulting on a secured loan, borrowers need to get educated on the loan terms, and learn what action steps to take if they start having trouble paying the secured loan back.
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 up front 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 asset you put up for a 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 asset 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 or work with a company like Experian, which offers consumers help in building your credit score, and getting you back on your feet, financially.
Planning for a Secured Loan
The takeaway? Getting a secured loan is a serious personal financial matter, and it takes plenty of planning and preparation to get the right secured loan for your unique needs, along with a solid plan to pay the money back.
The best strategy is to know the stakes, work with the right lender, and have a backup plan if you experience any financial troubles in repaying your secured loan. Cover those key issues and your secured loan experience can be a winning one, with you getting the loan you need, while keeping your valuable possessions in your name.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.
This article was originally published on April 30, 2018, and has been updated.