Secured Loans: What They Are And How They Work
3-Minute ReadDecember 03, 2021
There can come a time in an individual’s life when it’s necessary to pursue financial assistance in order to afford major purchases and work toward achieving some of their personal goals. Loans, for example, can provide a much-needed lifeline for prospective borrowers looking to buy a house, finance a new car or put their kids through school.
However, it’s important to be aware of the various types of loans available to you and how some might be better suited to your specific needs than others. Let’s explore secured loans and some of the instances in which this type of loan could be the best option for you.
What Is A Secured Loan?
A secured loan is a type of loan that requires a given borrower to put up some type of collateral to "secure" funding for the loan. The use of collateral assets is typically a method of reassuring lenders that their investment is worthwhile, and that the money owed to them by the borrower will successfully be paid back over the course of the loan term.
This collateral can be a variety of valuable items, including:
- Real estate properties
- CD or savings accounts
- Mutual funds
- Other tangible assets
How Does A Secured Loan Work?
You can apply for secured loans through financial institutions like banks and credit unions, as well as through online lenders.
Before approving you for a secured loan, your lender will need to verify that the value of the collateral asset you’re offering is approximately equal to the value of the secured loan.
They will also likely need to run a check on your credit score and history in order to assess your creditworthiness. Since the collateral attached to the loan agreement provides an added layer of protection for the lender and incentivizes the borrower to stay on top of their payments, lenders of secured loans may be more likely to take on borrowers who have slightly lower credit scores than other types of lenders.
Once you’ve been approved for your secured loan and have determined what you will be using as your collateral, your lender will often place a lien on the collateral assets – which gives them ownership rights over the assets – until the loan is fully repaid, at which point collateral ownership will transfer back to the borrower.
If the borrower fails to repay the loan, the assets can be liquidated, sold or repossessed in order to cover the remaining expense.
Types Of Secured Loans
While there are several types of secured loans available to interested borrowers, there are a few types that are sought out more frequently than others to fulfill specific financing needs. Let’s take a look at those.
Mortgages are one of the most common types of secured loan. With a mortgage loan, the borrower puts up their mortgaged property as collateral for the lender, and if they fail to make their mortgage payments, the property can go into foreclosure and be taken away from the borrower.
Home Equity Loans
Another common type of secured loan is the home equity loan, which also uses the borrower’s home as collateral for the lender. Home equity loans can be a good option if you need access to a large sum of money all at once, and have substantial equity in your home. However, as with mortgage loans, your home can be foreclosed upon if you fail to make consistent payments on your home equity loan.
Home Equity Lines Of Credit
Home equity lines of credit (HELOCs) are lines of credit that, like home equity loans, are secured by the borrower’s equity in their home. This type of loan can be used for home improvement projects, your child’s college tuition or even a vacation, and you can repeatedly use the line and pay off the balance as needed over the course of your loan’s lifetime.
Secured Credit Cards
Secured credit cards differ slightly from traditional credit cards in that the borrower has to provide a cash deposit as collateral when they apply. If the borrower fails to pay off their secured credit card on time, money can be drawn from that cash deposit to cover the deficit on the bill.
As one might expect, funds for auto loans are secured by using the automobile itself as collateral for the lender. If the borrower fails to make their car payments, their car can be repossessed.
Secured Loans Vs. Unsecured Loans
While secured loans are backed by some kind of collateral, unsecured loans – like personal loans, student loans and credit cards – are not. Although unsecured loans can have higher interest rates, and although they can be a little more difficult to get approved for without the added layer of security that collateral provides for the lender, they often allow more freedom and flexibility for the borrower in terms of how they’re able to spend their funds.
Pros And Cons Of Secured Loans
There are several benefits and drawbacks that accompany choosing a secured loan for your funding needs.
Secured loans can be a great option for those who possess assets that would be suitable for use as collateral, and who feel confident in their ability to consistently make payments on their loan to avoid losing those assets.
This type of loan typically offers lower interest rates, and can be easier to get approved for as opposed to unsecured loans, since you’re providing additional protections for the lender by putting up collateral.
The biggest risk accompanying secured loans is that, if you fail to consistently make payments on the schedule laid out in the terms of your loan agreement, you can lose whatever valuable collateral assets you used to back the loan.
Secured loans are also more limited than unsecured loan types like personal loans and credit cards, as the money tends to be approved for specific purposes connected to your chosen collateral.
Whether or not a secured loan is the best fit for your needs ultimately depends on what you plan to use the loan money for. Having to put up collateral to appease your lender is a big ask, and in many instances, choosing to apply for a personal loan and avoiding the need for collateral altogether might be in your best financial interest in the long term.
Ready to explore your financing options? Talk to a Loan Expert and consider applying for a personal loan with Rocket LoansⓇ today!
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