A secured loan is a loan backed by collateral—financial assets you own, like a home or a car—that can be used as payment to the lender if you don't pay back the loan.
The idea behind a secured loan is a basic one. Lenders accept collateral against a secured loan to incentivise borrowers to repay the loan on time. After all, the prospect of losing your home or car is a powerful motivator to pay back the loan, and avoid repossession or foreclosure.
When you apply for a secured loan, the lender will ask which type of collateral you'll put up to "back" the loan. If you have trouble paying the loan, the lender can put a lien on the collateral (a lien is the legal term for the lender's claim to the borrower's collateral.)
The lender can keep the lien active until the loan is fully paid. At that point, the lien is lifted, and the collateral ownership reverts back to the borrower. In the event the borrower defaults on a secured loan, the lender can retrieve the secured loan collateral and sell it to cover any losses incurred on the loan.
That's why it's imperative for secured loan borrowers to understand what asset they're using as loan collateral, and to weigh the value of that asset against a possible lien or collateral loss if the secured loan falls into default.
Types of Secured Loans
Secured loans come in multiple forms, but the three most common types of secured loans include three financial consumer loan mainstays, all requiring appropriate collateral before the loan is approved.
- Mortgage Loans: Mortgage loans are at the top of the list of secured loans. Such loans are deemed "securable" by lenders because the borrower puts his or her house up as collateral. If the borrower doesn't pay back the secured loan, the home can go into foreclosure and the borrower can lose the home.
- Vehicle Loans: Loans for autos, boats, motorcycles and even private airplanes are considered secured loans, as the vehicles are used as collateral in securing the loan. Just like with a mortgage, failure to repay the secured loan can result in the vehicle being repossessed by the lender.
What Types of Collateral Can be Used to Back a Secured Loan?
Any asset allowed by law can be used to obtain a secured loan, although lenders will seek collateral that is liquid (i.e., easily sold for cash) and has a value roughly equal to the secured loan amount being borrowed.
Typically, secured loan collateral comes in the following forms:
- Real estate, including any financial equity earned since purchasing the residence
- Bank accounts, including checking accounts, savings accounts, certificates of deposit accounts, and money market accounts
- Cars, trucks, SUVs, motorcycles, boats, or other vehicles
- Stocks, mutual funds, or bond investments
- Insurance policies, including life insurance
- Precious metals, high-end collectibles, and other valuables
Secured vs. Unsecured Loans
Secured loan borrowers should weigh the value of obtaining a secured loan or an unsecured loan.
While a secured loan means a borrower will have to put up valuable collateral to obtain the loan, an unsecured loan isn't backed by any collateral. If you are late paying an unsecured loan or default on the loan, the lender has no right to any of your property or assets. Credit cards, student loans and personal loans are among the most common forms of unsecured loans.
Secured loans have several advantages over unsecured loans:
- Because you're putting collateral down, a secured loan is easier to obtain than an unsecured loan.
- Since lenders absorb less risk with secured loans, borrowers with weaker credit scores also find it easier to get a secured loan.
- Secured loans tend to offer lower interest rates than unsecured loans, making secured loans a good choice for borrowers on a tight budget.
- Secured loans also typically allow borrowers to get a bigger loan amount than with an unsecured loan, giving the secured loan borrower expanded financial options, although with more financial risk in the form of potentially lower secured loan repayment periods.
On the downside, getting a secured loan usually means less time to pay back the loan (as lenders would rather have the payment, plus interest, rather than the borrower's collateral assets.) In addition, given the complexities of properly valuing a borrower's collateral, the approval process for getting a secured loan normally takes longer than with an unsecured loan, where a response often comes in a day or two.