A secured loan is a loan backed by collateral that your lender can legally seize if you don’t make your payments. Secured loans are usually easier to get than unsecured loans, but it’s important to understand their benefits and drawbacks before applying for one.
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What does “secured loan” mean?
A secured loan is a business or personal loan that requires collateral—which is usually a valuable asset that you own, such as your car—as one of the conditions for you to borrow the money.
If you default on your loan (fail to pay it back), your lender can legally seize your collateral and sell it to make back some of the money that you failed to pay.
In many cases, your collateral will be whatever you used the loan to buy. For instance, mortgages and auto loans are both types of secured loans. When you take out a mortgage, your collateral is your house, and when you get an auto loan, your collateral is your car.
Examples of collateral on secured loans
The following are some of the most common examples of collateral:
- Real estate (such as your house or a business property)
- Vehicles (such as cars, motorcycles, RVs, trailers, or boats)
- Cash (including money in savings, checking, and certificate of deposit accounts)
- Stocks and bonds
- Business equipment
- Business invoices
- Insurance policies
- Valuable items (such as jewelry, musical instruments, antiques, or art)
- Collectibles (such as coin collections)
- Gold or other precious metals
- Upcoming paychecks
Are secured loans easier to get than unsecured loans?
Yes, secured loans are almost always easier to get than unsecured loans (which don’t have collateral). Lenders are more willing to extend secured loans to people even if they don’t have good credit scores.
Why are secured loans easier to get?
Secured loans are easier to get because they present less risk to lenders. There are two reasons for this:
- Incentive to repay: First, the risk of losing your collateral means that you have more incentive to repay the loan.
- Limited losses: Second, there’s a limit to how much the lender stands to lose if you can’t pay because they can always use your collateral to recoup their losses.
Types of secured loans
There are several types of secured loan you can get, which differ based on what you can use them to buy and what type of collateral you have to put forward.
Most common types of secured loans
You’re probably already somewhat familiar with the following types of secured loans:
- Mortgages: These are probably the most common type of secured loan and are secured by the property you’re buying, which serves as the collateral. As such, when your home is mortgaged, you risk losing it in a foreclosure if you fail to make payments. Only when you have completely paid off your mortgage do you get full ownership of the property.
- Auto loans: Auto loans (as well as loans for other vehicles, such as motorcycles, boats, and airplanes) are similar to mortgages in that the asset you buy is the collateral. In most cases, you’ll pay a deposit upfront and then follow a fixed payment schedule until you’ve paid off everything, at which point you gain full ownership of the vehicle.
- Secured personal loans: These are general-purpose loans. You’ll typically have to put forth an asset you already own as collateral, such as your savings account or a valuable possession like a car. The value of the collateral will usually determine the size of the loan you can take out.
- Secured business loans: Business loans are a lump sum that a lender (usually a bank) provides for growing your business. The collateral you can use for secured business loans can include office or manufacturing equipment, inventory, real estate, accounts receivable (money your clients or customers owe you), or even your own personal assets if you have a small business that doesn’t yet have enough collateral to secure the loan.
Other types of secured loans
The following types of secured loans are less common:
- Home equity loans: Home equity loans (also known as second mortgages) are installment loans that allow you to borrow a lump sum using the equity you have in your home as collateral (your home equity is the amount of your mortgage you’ve paid off).
- Life insurance policy loans: With these loans, the collateral you provide is some of the cash value of your life insurance policy—the amount that your beneficiary would get if you died or that you’d get if you canceled your policy. These loans aren’t available for all types of policies, and they can come with caveats, so you should ask your insurer for more information about them.
- Pawnshop loans: When you pawn an item, you’re technically taking out a loan and leaving the item as collateral. These loans are usually relatively small and have very high interest rates—sometimes as high as 1,300%, more than 130 times higher than the average for personal loans—which is why they’re often considered predatory loans. 1 2
Before taking out a secured loan of any type, you need to know how these loans work and what risks they involve.
How do secured loans work?
When you take out a secured loan, you’re placing something called a “lien” on whatever asset you’re using for collateral.
A lien gives your creditor the legal right to seize the asset in question if you fail to repay the money that you’ve borrowed.
When you take out a secured loan, the lien remains active until you’ve fully repaid the loan. If you can’t pay off the debt by the end of the repayment period, then your creditor can legally take possession of the asset you’ve used as collateral. Before taking out a secured loan, you should always carefully consider whether it’s worth risking your assets.
What happens if you default on a secured loan?
As mentioned, if you default on a secured loan, your lender will probably take possession of your collateral. In many states, they can even repossess your assets without notifying you. 3
When your lender claims your collateral, it’s known as repossession (or “foreclosure” in the case of real estate).
The repossession process will have severe consequences for your credit score. Both your initial missed payments and your eventual repossession or foreclosure will appear on your credit report, damaging your score. Both will remain on your report for seven years.
Note that having your property repossessed doesn’t automatically clear your debts. If your collateral isn’t valuable enough to cover what you owe, you might need to pay extra to cover your creditor’s loss.
How to avoid repossession if you can’t pay a secured loan
As you’ve gathered, having your property seized can be a financial disaster. The good news is that you can usually avoid it—repossession is a hassle for creditors, too, and it will rarely be their first choice.
To avoid repossession, you should carefully review the terms of your loan agreement and let your creditor know as soon as you start having trouble making payments on your loan. They may be willing to adjust your repayment schedule or work with you in other ways.
Secured loans vs. unsecured loans: what’s the difference?
If you’re looking for a loan, you should carefully weigh the differences between secured and unsecured loans and pick the type that’s right for you. Bear in mind that some loans, such as auto loans, are almost always secured.
The following is a list of the main differences between secured and unsecured loans:
Differences between secured and unsecured loans
| Secured loans | Unsecured loans | |
|---|---|---|
| Collateral requirements | Collateral required | No collateral required |
| Interest rates | Lower interest rates (because of the minimal risk lenders face) | Higher interest rates (because of the greater risk lenders face) |
| Score requirements | Less strict credit score requirements | Stricter credit score requirements |
| Lending limits | Higher lending limits | Lower lending limits |
| Application process | The value of the asset you’re using for collateral must be assessed, and this lengthens the application process | There’s no need to assess the value of the asset you’re using for collateral, so the process is faster than for secured loans |
| What happens when you don’t pay | When you stop paying, your lender can seize the assets you’ve used as collateral. | When you stop paying, your creditor usually charges off your debt and sends it to a debt collection agency. Debt collectors then start trying to collect payments from you and may resort to a lawsuit. |
Should I apply for a secured loan?
You should apply for a secured loan if you have a solid plan for repayment and are confident that there’s no possibility you’ll get overwhelmed with debt and risk losing your home, car, or other assets.
If there’s a strong possibility you’ll get behind on payments, you should consider the alternatives before you decide to take out a secured loan.
What are the best alternatives to secured loans?
If getting a secured loan doesn’t seem right for you, you can also consider the following types of credit, most of which are available even if you have a bad credit score:
- Secured credit card: Much like secured loans, secured credit cards require a cash deposit as collateral, which the credit card company will keep if you default on your payments. 4 Responsibly using a secured credit card is one of the safest and easiest ways to improve your credit score.
- Unsecured credit card: Even though secured credit cards are easier to get, there are still unsecured credit cards for people with bad credit. This is a good option if you don’t want to risk putting down a security deposit. Just be very careful to pay your bills on time, as these cards usually have higher interest rates.
- Unsecured loan with a co-signer: If you have a cosigner (someone who will assume responsibility for your loan if you can’t pay), you might be able to qualify for an unsecured loan you wouldn’t have otherwise been able to get.
- HELOC: Like home equity loans, home equity lines of credit (HELOCs) use your equity in your home as collateral. However, unlike home equity loans, they’re a type of revolving credit (which means they’re similar to credit cards). Most HELOCs give you a 10-year period, known as the “draw period,” during which you can use them like a credit card. 5 Eventually, you’ll enter a repayment period, in which you’ll have to repay any remaining balance according to a fixed schedule. 6
- Paycheck advance from your employer: If you have a good relationship with your employer, you can ask them for an advance on your paycheck. This is a good option if you need a little extra cash because they probably won’t charge you any interest.
Payday loans are not a good secured loan alternative
If you don’t want to take out a secured loan but none of the options above suit you, you might be considering taking out a payday loan (a high-interest loan with a very short term, such as two weeks). Our advice is: don’t.
Payday loans are a popular way to get quick cash but are notoriously expensive. A typical two-week payday loan has a fee of $15 per $100, which is equivalent to a yearly interest rate of nearly 400 percent—in contrast to personal loans, which have an average interest rate of around 5%. 7 1
Payday loans are risky because it’s easy to get into a cycle of repeatedly using them to pay off the previous loan. Avoid them unless you have absolutely no other options, and if you’ve taken one on, do your best to get out of payday loan debt as quickly as you can.
How do I apply for a secured loan?
You can get secured loans from various types of lenders, including:
- Banks
- Credit unions
- Online lenders
- Auto dealerships
- Mortgage lenders
Before you apply for a secured loan, check your credit score. This will give you an idea of whether you meet the credit score requirements for the loan you want and whether you should improve your credit score first to get a better interest rate or explore alternative financing options, like bad-credit personal loans or bad-credit car loans.
Checking your credit reports is also a good idea so that you can spot errors and dispute items on your credit report that could be lowering your score. You can request free copies of your credit reports at AnnualCreditReport.com.
