Learn all about secured loans, what they are, how they work, and the different types of collateral loans available in the financial world.
There are many different types of loans, including fixed and variable rate loans, installment and short-term loans, and unsecured and secured loans. All of these many types of loans come with different features, terms, and requirements that go into what they are and how they work.
Secured loans also come in many forms and are each backed by different types of collateral to secure the loan. This type of loan allows borrowers to use their assets to achieve a wider range of financial services. Understanding how these loans work, the different kinds available, and their pros and cons is essential to understanding if this type of loan is the right choice for you.
What is a Secured Loan?
A secured loan is a type of loan that is backed or secured by collateral or an asset the lender can claim in case of default. This type of loan can also sometimes be referred to as a collateral loan, asset-based lending, or secured debt.
So a secured loan is always backed by some form of collateral, like a house, car, or savings account. This means that the loan money you borrow is, in a way, insured by the asset you connect to the loan agreement.
Meanwhile, unsecured loans are any loan that isn’t backed by a form of collateral. Instead, this type of loan is usually backed by things like your income statements and creditworthiness. This is why you might be able to use secured loans for bad credit, since they generally consider the asset’s worth more than your credit score.
How Secured Loans Work
The process of how a secured loan works might look different depending on the lender and the type of collateral involved. But in general, this type of loan will go through the following process:
First, you’ll find a reputable lender you can trust to start your application, then the lender will assess the collateral during the loan underwriting process, and then, if you get approved, you’ll be given the funds and enter into a repayment schedule.
1. Fill Out an Application
The very first thing you’ll need to do to get any type of loan is to fill out an application. In general, loan applications ask for information like your basic contact information, a form of identification, your social security number, bank statements, and proof of income.
But for a secured loan, the application process may include a few extra steps and details. For example, the lender might ask for details about the asset tied to the loan, like its value and condition. You might also need to provide additional documentation that proves your full and clear ownership of the property.
2. Collateral Assessment
Another step that is often necessary in getting this type of loan is a collateral assessment. The lender or creditor will usually need to inspect the assets in some way before proceeding with the loan application.
A collateral inspection may help the lender assess the value of the asset and then use that market value to determine how much you can borrow. This inspection might also be necessary to make sure the collateral meets their requirements for an asset-based loan.
Because an inspection of some kind is often required, this type of loan application might have to happen in person rather than online. An inspection on a home for a mortgage loan might also require the prospective homeowners to pay for the inspection themselves.
3. Get Funding and Make Loan Payments
If approved, then the borrower will sign the loan agreement, get funded, and a repayment process will begin. While you’re making monthly payments, the lender will have a lien on the asset connected to the loan. Once the loan is fully repaid, then the lender will release their lien on the collateral to return full ownership back to the borrower.
Types of Secured Loans
There are a number of different types of secured loans that use different types of collateral to secure the loan funds. Some examples of secured loans include mortgages, home equity lines of credit (HELOC), auto loans or car loans, title loans, 401k loans, certificate of deposit (cd) loans, secured credit cards, secured personal loans, pawnshop loans, and business loans.
- Mortgage loans use the house or real estate property as collateral for the loan to help homeowners finance a house or other real estate property.
- Home Equity Lines of Credit (HELOC) use your home’s value or equity as collateral for the line of credit.
- Auto loans use the car or vehicle as collateral for the loan to help car owners finance a car.
- Title loans use the market value of a car or vehicle the borrower already owns to secure loan funds.
- 401k loans use the money in your 401k account as collateral to get loan funds.
- Certificate of Deposit (CD) loans use the money in your CD account as collateral to get loan funds.
- Secured credit cards use a cash deposit to insure the credit limit available on the card.
- Secured personal loans can use various assets like a savings account, stocks, or personal property to secure loan funds.
- Pawnshop loans hold a piece of personal property, like jewelry or a watch, at a pawnshop store until you repay what you borrowed to reclaim the item you lent to secure the money you needed.
- Business loans use your business assets, like equipment, inventory, or accounts receivable to get the secured business loan you need.
Pros and Cons of Secured Loans
All financial services come with their own pros and cons. The pros of secured loans are that they can be easier qualify and get approved for with the help of your property or asset.
For example, if you have bad credit, then you might find more success using an asset to secure loan funds with a secured loan. Since an asset helps insure the loan funds, these types of loans can sometimes be more affordable with lower rates and fees.
The main cons of secured loans are that they carry the risk of losing the collateral you connected to the loan if you default. If you fail to repay the loan, your property could be repossessed to cover the money you owe. The application process for a secured loan can also take longer than unsecured loans since an inspection of some kind is often necessary.
How to Get a Secured Loan
The process to get a secured loan is a bit different from an unsecured loan. In general, a borrower will need to shop around for a trustworthy lender, assess the collateral they plan to use for the loan, and gather the documents they need to give themself the best chance of getting approved.
Pick a trustworthy secured loan lender. Shop around and do your research to find the best lender and loan option for your needs.
Assess your collateral. Assessing your property can help you see how much you can get with a collateral loan and your chances of getting approved.
Gather documents. Gather together the documents you’ll need to apply to make sure you have everything you need to get approved.
Unsecured vs Secured Loans
The difference between unsecured and secured loans is that secured loans are tied to a form of collateral and unsecured loans are not. So if a financing option is linked to an asset of some kind, then it’s a secured loan, meaning the loan funds are secured by
Secured Loan FAQs
Still have some questions about secured loans and how they work? Let’s go over some of the most frequently asked questions all about secured loans.
Do I need a bank account to get a secured loan?
In most cases, you will need a bank account to get a secured loan. Lenders typically require a bank account for various reasons, such as verifying your financial stability, transferring loan funds, and setting up automatic payments.
Do secured loans have lower interest rates?
Secured loans may have lower interest rates compared to unsecured loans because they are backed by collateral, which reduces the lender's risk. Since the lender can seize the collateral if you default, they are often more willing to offer lower rates. However, your rate will ultimately depend on factors like your credit score, the value of the collateral, and the lender's policies.
What happens if I default on my secured loan?
If you default on a secured loan, the lender may seize the collateral you pledged when you took out the loan. This means that if you fail to make the required payments, you could lose your home, car, savings account funds, or whatever asset you used as collateral to secure the loan funds.
Aside from losing your collateral, defaulting on a loan can severely impact your credit score, making it more difficult to obtain credit in the future. This is why it’s important to take into account your financial situation and the options available to you before taking out any type of loan.
What to do if you can’t repay a secured loan?
If you find yourself unable to make payments on a secured loan, it’s important to take the right steps.
Contact Your Lender. Reach out to a loan representative at your lender as soon as possible to explain your situation. Lenders may be able to modify your repayment plan, offer temporary forbearance, or refinance your loan to help work with your financial situation.
Seek Financial Counseling. Consider speaking with a financial counselor. They can help you make a plan for how to tackle debts and how to improve your overall financial situation.
It’s important to take action as soon as possible when you’re in a situation where you might not be able to make loan payments. Whenever you’re borrowing money, make sure you consider the repayment terms carefully to make sure they work inside your budget. And if something changes, make sure you contact your loan provider to address the situation.
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