Do you find it challenging to qualify for an unsecured personal loan due to limited credit history or financial circumstances? Have you been eyeing a major purchase but hesitating due to the high interest rates on loans or credit cards?
Consider taking out a secured loan. By using an asset as collateral to back the payments, you can enjoy lower interest rates and higher borrowing limits.
So, what are secured personal loans exactly? Let’s explore the main types of secured loans, their key benefits, limitations, and ways to apply.
What is a Secured Loan?
Understanding the key differences between secured vs unsecured loans is key when deciding which borrowing option aligns with your financial goals.
With a secured loan, you use your assets as collateral. This can be a vehicle, life insurance, or property, and it serves as a guarantee of repayment. This means the lender places a lien on your asset. If you should default on your payments, the lender may claim the asset to recover the unpaid balance.
Most secured personal loans are typically easy to qualify for, as they pose a lower risk to the lender. Additionally, a secured loan has higher borrowing limits and better overall terms due to the security buffer.
An unsecured loan, on the other hand, allows you to borrow money without having to back it with collateral. Eligibility criteria, in this case, are much stricter: a strong credit score and history are necessary to qualify. Due to more risk on the lender’s side, an unsecured personal loan typically comes with lower borrowing limits and higher interest rates compared to secured loan alternatives. Both secured and unsecured loans are great options, they simply suit different kinds of borrowers.
Types of Secured Loans
The type of collateral you use to back your payments will determine your secured personal loan type:
Collateral secured loans. The lender puts a lien on your car and can repossess it if you fail to make payments. Typically, car title loans come with higher interest rates and fees than other secured personal loans. Still, they are a great option if you have a lower credit score. This type of loan is not as widely accessible due to the high risks involved, such as regulation, short repayment terms, high borrowing costs, and potential loss of the vehicle, so you should consider alternative options for a vehicle loan.
Car loans. Auto loans are a more common and structured financing option for purchasing a vehicle. Unlike title loans, which use an already-owned vehicle as collateral, car loans are secured by the vehicle you’re buying. Similar to a mortgage, the lender retains a lien on the vehicle until the loan is fully repaid.
Home equity line of credit (HELOC). With this secured loan, you can borrow against the equity in your home. A HELOC provides a revolving credit line that you can access, repay, and reuse up to a set limit.
Home equity loans. These secured personal loans allow you to borrow a fixed loan amount against your home’s equity, with predictable monthly payments that include principal and interest. Unlike HELOCs, these loans are not revolving.
Mortgages. With a mortgage loan, you also pledge your house as collateral to back your payments. With this secured loan, you can borrow large sums, with repayment periods typically spanning 15 to 25 years.
Life insurance loans. These loans let you borrow against the cash value of your life insurance policy. Terms vary depending on your insurance provider, and borrowing against your policy reduces its cash value and death benefit until the loan is repaid.
Secured credit cards. A cash deposit serves as collateral in this case and acts as your credit limit. These cards are a great option for building or rebuilding credit, as they function like regular credit cards.
Loans secured by funds on deposit. These loans are backed by your own money held in a deposit account, such as a savings or term deposit. Since the loan is fully secured, lenders typically offer very low interest rates. If you default, the bank can use the deposited funds to repay the outstanding balance.
How Does a Secured Loan Work?
Based on the specifics of the personal loan you opt for, the exact application procedure will vary.
The primary condition for a secured loan is having collateral to back your payments. The chief requirement for securing a loan is placing a lien on valuable physical or financial assets you own.
Collateral protects the lender against the risk of loss if you fail to repay the loan. The lender may claim the collateral if you stop making payments and use it to recoup the unpaid secured loan balance.
Some types of secured loans, such as loans secured by funds on deposit, are easier to qualify for. They are backed by your money and, therefore, come with low interest rates and flexible terms. Other secured loans, such as HELOCs and mortgages, may have stricter eligibility requirements, such as a stable income, good credit history, and sufficient equity in your home.
A secured loan is less risky for the lending party. So, it typically comes with lower interest rates, higher borrowing limits, and more flexible terms. Read on to explore other benefits and potential risks associated with secured personal loans.
Pros and Cons of a Secured Loan
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How to Get a Secured Loan
To get a secured loan, decide how much you’d like to borrow and what valuable asset you can place as collateral. These two factors will be critical in narrowing down your options among different types of secured personal loans. However, the process doesn't end there.
Eligibility for mortgages or HELOCs involves more detailed requirements. Lenders will review your credit report and score during the application process. Additionally, your property must undergo an appraisal to determine its value as collateral, which may involve extra costs.
Once you’ve done your research and are ready to apply for a specific secured loan, ask your lender which documents they require from you. Submit your application, and upon approval, follow the negotiated terms and conditions of your agreement.
What Happens When You Default on a Secured Loan?
If you fail to make payments on your loan, the lender might commence the process of repossessing the asset they placed a lien on. Repossession will significantly impact your credit history and credit score. Vehicle repossession, for example, can result in over 150-point loss on your credit score.
Though the process varies across lenders, it usually takes up to three months for the lender to repossess your asset. It takes even longer to sell land and residential property. You could leverage this extra time to update your delayed payments.
Remember that having your asset seized upon default doesn’t guarantee the debt is paid off. You may still owe money to the lender if the repossessed asset isn’t sufficient to cover the unpaid secured loan balance in full.
In some cases, the lender might file a case to a court, known as a deficiency judgment, to demand payment for the outstanding debt amount.
What to Do If You Can’t Repay a Secured Loan
If you can’t repay your loan, the best action is to inform your lender about it. Ideally, you should contact your lender before you fall behind on your monthly payments. While having a few missed payments will undermine your credit score, if you get back on track and repay any outstanding debt, the risk of property repossession will be minimized.
Most lenders are likely to suggest an alternative repayment plan if you aren’t able to keep up with the current schedule. For example, you might negotiate an extended term for a secured loan, making your monthly loan payments more manageable.
The Bottom Line
A secured loan is a common borrowing tool with lower interest rates and higher borrowing limits. At the same time, a secured loan requires collateral as a main condition for borrowing. So, you can lose a valuable asset should you default on your loan payments.
With an array of secured personal loans available, you can select an option that best matches your financial situation. If you’re unsure what type of loan is better for you or want to learn more, our advisors are happy to help. Contact us today for a consultation.