What Is A Secured Loan?
A secured loan is a loan that is guaranteed by collateral pledged by the borrower. The most common types of collateral used for a secured loan include a vehicle, property, and valuable commodities. Should the borrower fail to pay back the loan, the lender can seize ownership of the pledged asset and sell it to recoup their losses.
Secured debt usually carries lower interest rates than unsecured debt because there is less risk involved for the lender. There is also more incentive for the borrower to keep up with their bill payments as the value of the collateral will almost always exceed the value of the loan.
There are two broad categories of secured debt: lump sum-fixed term loans and revolving credit loans. In the first case, the borrower receives the loan as a lump sum deposited into their account and there is a fixed term for repayment. The second case works like a line of credit. The borrower can draw as much, or as little, as they please and there is no set payback term.
All About Collateral And Liens
Collateral can be seen as a guarantee to the lender that they will not lose money on a loan. Should the borrower default on their loan the collateral is liquidated by the lender to insulate themselves from any losses. Not all items of value are accepted by the lender as collateral. Below is a list of the most commonly accepted forms of collateral.
- Real Estate: This is the most common form of collateral and so frequently used that specific loan vehicles have been created to allow people to borrow against the equity in their homes.
- Motor Vehicle: Cars, trucks, SUVs, motorbikes, boats, RVs, and any other type of motor vehicle that has some value can also function as collateral.
- Investment Vehicles: Although less popular, investments such as stocks, mutual funds, and bonds can also be occasionally used.
- Insurance Policies: Certain kinds of insurance policies, such as life insurance, can be used to secure a loan.
- Share Secured Loan: Many people will hear this and wonder ‘what is a shared secured loan?’ A share secured loan is any loan backed by the capital the borrower carries in their share account, more commonly known as a savings account.
When an asset is used as collateral there is a lien put on it. This lien gives the creditor the legal right to seize and sell the asset should the borrower default on their loan. While there is a lien on an asset, the owner is not allowed to sell it until the lien is removed, which requires the loan to be paid off in full.
For example, let’s say an individual uses their vehicle to secure a loan of $15,000. A lien would then be placed on the vehicle until the debt is paid off. If the individual defaults on their loan, the lender has the right to seize the vehicle and sell it to recoup their losses.
Secured Loan Types
There are many different types of secured loans, all requiring an appropriate form of collateral before approval. Below are the three most common types of secured loans.
The vast majority of people who purchase a home do so through a mortgage. This is because very few individuals can afford to pay for a home outright, they save up a down deposit and the bank lends them the rest. The reason why a mortgage is considered a secure loan is because failure to pay can result in a foreclosure, meaning the creditor takes possession of the property for liquidation.
While not everyone purchases a home, most people buy a vehicle at some point. Auto loans work the same way as mortgages. The borrower receives the vehicle and is expected to make monthly payments until the loan is paid off. Failure to do so will result in the lender repossessing the vehicle.
Not having a credit card can be a major inconvenience. Many services, such as cell phone plans, media streaming providers, and online shopping require one. This can be difficult for those with no credit or poor credit.
Due to this reality, secured credit cards exist. With a secured credit card, the recipient gives the lender money upfront equal to the credit limit of the credit card. This gives the individual access to the convenience of a credit card and removes any risk for the lender.
A secured loan carries a level of responsibility that unsecured debt does not. With unsecured loans, failure to repay debt will result in a poor credit score and phone calls from debt collectors. With secured loans, failure to repay the loan will result in the loss of the asset used to guarantee the loan.