When you need to borrow money, many options are available. One financing choice you may have come across is a secured personal loan.
But what is a “secured” loan exactly? Read on to find out how a secured personal loan works and whether it’s the right option for your needs.
What Is a Secured Loan and How Does It Work?
A secured loan requires the borrower to put up collateral in order to be approved. “This collateral serves as a guarantee to the lender that they will be able to recover the loaned amount in case the borrower is unable to repay the loan,” says Raquel Curtis, a personal finance coach known as The Boujee Banker. In other words, if you don’t make your loan payments, the lender can seize the asset backing the loan to recoup the money.
Because the lender has a way to recoup its losses, secured loans generally have lower interest rates than unsecured loans, which don’t require any collateral.
Types of Secured Loans
Secured loans come in many forms. Some of the most common types of secured loans include:
- Mortgage. A loan used to purchase a house or other real estate property, where the property itself acts as collateral.
- Home equity loan. A loan that allows homeowners to borrow against the equity they have built up in their home. These loans are secured by the borrower’s home.
- Car, boat and RV loans. Loans used to purchase vehicles, where the vehicle itself acts as collateral.
- Secured credit card. A credit card that requires a deposit, which serves as collateral for the credit limit.
- Equipment loan. A loan used to purchase equipment for business or personal use, where the equipment itself acts as collateral.
What Is a Secured Personal Loan?
Another type of secured loan is a secured personal loan. “Borrowers use secured personal loans for a variety of reasons, such as consolidating debt, financing a home renovation or paying for unexpected expenses,” says Andrew Lokenauth, founder of Fluent in Finance.
He adds that the typical eligibility requirements for a secured personal loan include having a good credit score, a steady income and a clear title to the collateral being used. “Some lenders may also require a minimum credit score or a certain amount of collateral,” he says.
The typical rates and terms for a secured personal loan are also generally lower than those for an unsecured personal loan, and the interest rate is usually fixed, which means that it will not change over the life of the loan, according to Lokenauth. Repayment terms vary, but typically range between one and five years. These loans are generally available from banks, credit unions and online lenders.
Pros and Cons of Secured Personal Loans
When deciding whether a secured personal loan is right for you, here are some major factors to consider.
- Lower interest rates: Since secured loans are backed by collateral, they are considered less risky for lenders, which means they can offer lower interest rates. This not only results in lower monthly payments, but also less money spent on interest over the life of the loan.
- Larger loan amounts: Because there is a valuable asset backing the loan, you may be approved to borrow a larger amount with a secured personal loan than an unsecured loan.
- Easier to qualify: Secured personal loans are also often easier to obtain. If you have fair credit or lower income, you may get approved for a secured loan though you were denied an unsecured loan.
- Improve credit score: Repaying a secured loan on time can help improve your credit score, as it demonstrates your ability to manage debt responsibly. In fact, payment history is the most impactful credit factor at 35% of your score. A secured loan can also help improve your credit mix, which accounts for another 10% of your score.
- Risk of losing collateral: One of the biggest drawbacks to a secured loan is that if you default, the lender can take possession of the collateral. Before taking on a secured personal loan, you must consider whether you can really afford to lose that asset if you’re no longer able to make payments.
- Assets are tied up: By securing the loan with an asset, you aren’t able to take advantage of its value in other ways. For example, if you use a bank account as collateral, you could be restricted in how you use those funds.
What to Do If You Can’t Repay a Secured Personal Loan
Since your collateral is at risk if you don’t make your loan payments, it’s important to ensure you can afford to take out a secured personal loan. That said, there could be an unforeseen financial emergency in the future that makes it difficult to keep up with payments. In that case, you should seek a solution as soon as possible.
One option may be to refinance the loan. If your credit score has improved or your income has increased since you first took out the loan, you may be able to refinance to get a lower interest rate or more favorable terms. That could open up more cash flow to be able to cover payments.
If you’re facing a more dire financial situation, you may need to pursue a loan modification. You may be able to negotiate with the lender to change the terms of the loan, such as extending the repayment period or temporarily reducing the payment amount.
It can help to seek the assistance of a reputable credit counseling agency, especially if you owe a large amount or several debts. A credit counselor can help you create a budget and come up with a plan to repay the loan.
Secured Personal Loan Alternatives
Although secured personal loans can be a convenient, low-cost way to borrow money, they aren’t your only option. These are a few alternatives you should consider:
- Unsecured personal loan. This type of personal loan is not backed by collateral, making it a higher risk for the lender. That often translates to higher interest rates. However, if you have good credit, you may be able to borrow an unsecured loan with a low rate and favorable terms.
- Credit card. With a credit card, you can borrow against your credit line and pay down the balance as needed, and no collateral is required. However, interest rates for credit cards tend to be quite a bit higher, so perhaps consider one with an introductory 0% annual percentage rate.
- Personal savings. Instead of borrowing money for an expense, you could save up the cash you need instead. This might mean waiting much longer to make the purchase, as well as using up cash that could be socked away in an emergency fund or invested.
Is a Secured Personal Loan Right for You?
If you need to borrow money for a major expense or want to consolidate high-interest debt, a secured personal loan could be a solid choice. These loans tend to have more favorable interest rates and terms than other borrowing options, such as credit cards. However, they’re not right for everyone.
“A secured personal loan can be a great option for borrowers who have good credit, a stable income and collateral to put up as security,” Curtis says. “However, it is important to consider all the pros and cons and compare different loan options before making a decision.”
If you’re unsure about the best way to go about securing financing, Curtis recommends consulting a financial advisor or professional first.