What Is a Secured Loan?

How secured loans work

Secured loans work by reducing the lender’s risk through collateral, which can be seized if the borrower defaults. When you apply, you’ll pledge an asset, like a car or house, to back the loan. You can apply for a specific amount, just as you would with other loans. The lender will check your credit score and history, and you can be approved for various terms and rates.

Your collateral can be seized if you don’t pay back your loan.

When you sign your loan documents to borrow the money, your lender places a lien on the asset you pledge. Once you pay off the loan in full, the lender releases any lien on the collateral and any right to seize your pledged asset.

Types of secured loans

There are several types of secured loans, each backed by a specific kind of collateral. Here are some common examples of secured loans:

Home loans

Mortgage loans are secured by your home. If you default, the bank can foreclose and take the property. Also, home equity loans and home equity lines of credit (HELOCs) are secured by your home’s equity, allowing you to borrow against the value you’ve built in the property.

Car loans

Most auto loans are secured by the vehicle you purchase. This gives the lender a backup plan to recover losses if you stop making payments. With car title loans, you borrow against your vehicle’s equity, and the lender can repossess the car if you don’t repay the loan.

Secured personal loans

Secured personal loans let you pledge an asset to borrow funds for general use. A lien stays on the asset until the loan is repaid. Secured personal loans are generally suitable for people with fair or poor credit, or people who otherwise can’t qualify for an unsecured loan.

Pawn shop loans

Pawn shop loans let you borrow against an item of value. If you don’t repay on time, the pawn shop can keep the item. Pawn shop loans typically have high rates and fees.

Business loans

Business loans often require collateral like equipment or property. You might also need to sign a personal guarantee for a loan, meaning you’re responsible even if the business fails.

» MORE: What are common small business loan terms?

Pros and cons of secured loans

Here are a few pros and cons to consider before applying for a secured loan:

What to look for in a secured loan

As you’re shopping around and comparing multiple lenders for a secured loan, make sure to consider each of the following factors:

Collateral

Confirm what type of collateral you need to secure the loan. Consider if the required collateral is worth risking, such as your home with a home equity loan or a vehicle with an auto loan.

Loan amount

Each provider has its own range for loan amounts. Your credit score and other factors influence how much you can borrow.

Loan qualifications

Lenders generally have a minimum credit score for a loan, and they may have income or other credit requirements.

Interest rate

The lowest interest rates are generally reserved for people with the highest credit scores. Some loans include a fixed interest rate, which stays the same the entire length of the loan, while others have a variable rate, which fluctuates with the market.

Repayment terms

Like all loans, secured loans will have specified repayment terms.

“Longer terms may have higher overall interest costs but lower monthly payments,” said Joseph Catanzaro, a financial advisor at Oak & Stone Capital Advisors. “Shorter terms may result in higher payments but lower interest costs over time.”

Fees

Lenders may include different types of fees with a secured loan, such as origination fees, administrative fees, prepayment penalties or late fees.

How to get a secured loan

Many types of secured loans are available through a bank, credit union or online lender. You can generally apply for a loan online or at a branch, if available.

1. Review your credit score and report

Review your credit report and credit score to check for any errors before applying for a secured loan. You’ll typically need a good to excellent credit score for home loans and car loans, though secured personal loans may accept fair or poor credit.

You can get your credit report for free from AnnualCreditReport.com, and you can generally get your credit score for free through your online bank account.

2. Compare options and review qualifications

Research and compare loan offers from at least a few different lenders. Make sure that you qualify for the secured loan you’re interested in before you apply. Each lender sets its own qualifications for secured loans, such as income, credit score and debt-to-income (DTI) ratio requirements.

Get prequalified

You can get prequalified for many types of secured loans online without any impact to your credit score. This will help you learn which types of loans and rates you may qualify for before you apply.

3. Gather necessary information and apply

The information and documentation you’ll need to provide will vary depending on the type of secured loan you’re applying for. Some of the information you may need to provide will include:

• Photo ID
• Proof of address
• Proof of income and employment
• A list of your current debts
• The collateral you plan to pledge, such as a vehicle title
• An appraisal of the item

When you’re ready to apply, you can typically submit an application for a secured loan online or in person.

» COMPARE: Best secured personal loans

Secured vs. unsecured personal loans

Secured loans and unsecured loans are both types of personal loans that offer varying loan terms and competitive interest rates for well-qualified borrowers. While secured loans require collateral, unsecured loans don’t require collateral.

Approval and interest rates for unsecured loans are based solely on a borrower's income, credit score and credit history, while secured loans allow borrowers to pledge an asset as collateral to guarantee the loan.

Here are a few differences between secured and unsecured loans:

Loan approval

Secured loans might have an easier approval process since they require collateral, which reduces risk for the lender. This makes lenders more likely to extend a loan, even if borrowers have bad credit or no credit.

With unsecured loans, lenders rely on a borrower's income, credit score and credit history to assess a borrower’s ability to repay a loan. This can make the approval process lengthier, and it’s typically harder to get approved.

Interest rates

Secured loans often have higher interest rates, particularly if a borrower has poor credit. Unsecured loans typically offer a wide range of interest rates, with the best rates reserved for borrowers with excellent credit.

Loan amounts

The amount you can borrow on an unsecured loan depends heavily on your income and credit score. With a secured loan, you might qualify for a larger amount if the collateral you pledge is valuable enough.

Risk

Defaulting on an unsecured loan can hurt your credit and lead to lawsuits or wage garnishment. A secured loan carries the same credit risks as an unsecured loan, plus the added possibility of losing your collateral. If you can’t repay a secured loan, your collateral is at risk of being seized by your lender and sold to recoup losses.

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