Secured loans are loans that are protected by collateral. When you apply for a secured loan, the lender will want to know which of your assets you plan to put up as collateral. The lender will then place a lien on that asset until the loan is repaid in full. If you default on the loan payments, the lender can claim the collateral and sell it to recoup the loss.
It is important to know precisely what you are promising, and what you stand to lose, before you take out a secured loan.
What types of loans are secured?
Lenders want to know that they have leverage once you walk away with their money. When they place a lien on your collateral, they know that in a worst-case scenario they can take possession of the assets you’re using as collateral. This does not guarantee that you will repay your loan, but it does give lenders a greater sense of security and gives the borrower more impetus to repay the loan.
Most credit cards are unsecured loans, meaning creditors have nothing but your word that you will repay the debt. Other loans are normally secured, however. Some examples of secured loans include:
- Home equity line of credit
- Auto loans
- Boat and recreational vehicle loans
- Loan for land
- Business loan
Secured loans are usually the best way – and often, the only way — to obtain large amounts of money. Nearly anything can be accepted as collateral, as long as it is allowed by law. Lenders prefer assets that are easy to collect and can be readily turned into cash. What you use as collateral likely will depend on whether your loan is for personal or business use. Examples of collateral include:
- Real estate, including equity in your home
- Cash accounts (Retirement accounts typically do not qualify.)
- Cars or other vehicles
- Machinery and equipment
- Insurance policies
- Valuables and collectibles
Secured loan vs. unsecured loan
Unsecured loans, such as a personal loan, will cost you more in interest. Some predatory lenders charge astronomical rates for unsecured loans because borrowers with bad credit who can’t get a secured loan often turn to unsecured loans.
You’ll also have less time to repay a secured loan, and the approval process for such a loan is typically lengthier.
What happens if you default on a secured loan?
After a missed payment or two on a car, boat or RV, the lender is likely to repossess it. In many states, the lender is not required to give you notice of the repossession. To make matters worse, repossession is not the end of the matter. If the repossessed asset does not sell for enough to cover the amount of your loan, you are responsible for the difference.
For example, if you owe $20,000 when you stop making payments on a boat and the boat is repossessed and sold for $15,000, you will owe the bank the outstanding $5,000. The repossession stays on your credit report for seven years.
If you miss payments on a mortgage, home equity loan or business loan, the lender has a lengthier process to recoup its money. In about half of the states in the U.S., a lender must go to court to foreclose on a property. In the other half, the lender is required to provide you with advance notice of foreclosure. In either case, it is a good idea to call your lender to see if you can negotiate a loan modification that will allow you to keep your home or business.
Use Bankrate’s mortgage refinance calculator to determine whether a refi is right for you.