Two different loan types are available for borrowers to apply for to borrow money: a secured loan and an unsecured loan. Student loans, credit card purchases and personal loans fall under the umbrella of unsecured loans. But what is a secured loan?
A secured loan is a loan that has collateral attached to it. If you miss a payment or go into default, the creditor can take your personal assets — usually what you purchased with the loan — as payment. For example, a person might have his home foreclosed or his vehicles impounded due to a series of missed payments.
How Secured Loans Work
A secured personal loan usually comes with a lower interest rate than what you’d find with an unsecured loan. Secured loans have lower interest rates because lenders consider secured loans to be lower-risk because personal property is attached as payment protection. Secured debt also comes with longer lending terms and higher borrowing limits.
The eligibility requirements for a secured loan vary by the type of loan you’re trying to obtain. For example, applying for a secured credit card will require fewer prerequisites than applying for a 30-year home mortgage. For personal loans, lenders usually require putting down collateral such as a savings account, CD or home equity.
Along with establishing your security — that is, what you are putting down to secure your loan — in many cases, lenders will check your credit score, proof of income and employment history. For most secured debt, your credit score will determine your interest rate.
The default process varies by state and lender, but generally, 150 days of nonpayment puts your loan into default. Defaulting on your secured loan allows the creditor legal right to repossess or foreclose your property. The lender can also have your personal assets sold to satisfy the debt. The lender doesn’t need the permission of a judge to take over your property.
Types of Secured Loans
A number of loans fall into the category of secured loans. The most common secured loans include:
- Car loans: Auto loans are considered secured debt because the car can be taken as collateral if payments go into default. This applies for a new car loan, used auto loan and RV loans.
- Secured credit card: Most credit cards are considered unsecured debts, but for those who have lower credit scores, secured credit cards are available. A cash deposit is used as collateral for a secured credit card, which can help build or reestablish a borrower’s credit score.
- Mortgage: A mortgage is considered a secured loan because the home is considered the lender or bank’s property if the owner defaults on payments.
- Home equity line of credit: Homeowners can take a home equity line of credit out on their homes. These secured loans are based on the amount of home equity, which is calculated by taking the current market value of the home minus the amount the homeowner still owes.
Secured Loans Are Less Expensive
When deciding between a secured versus unsecured loan, think about the type of debt you want to take on, as well as the pros and cons of each kind of loan. Secured loans are easier to qualify for and can come with better interest rates, whereas unsecured loans don’t require a security deposit of personal assets.
For example, a vehicle can be purchased with a secured debt, such as a used car loan, or with unsecured debt, such as a signature loan. However, it’s easier and less expensive to purchase a vehicle with secured loans than with unsecured loans that come with higher interest rates.