What is a secured loan?

A secured loan is a loan that’s backed by some type of collateral, such as a vehicle or real estate. If you don’t repay the loan, the lender can seize the collateral and sell it to get its money back.

Secured loans are easier to qualify for than unsecured loans, but they are riskier for the borrower because of the potential for loss of a valuable possession if the loan goes into default.

Types of secured loans

Most secured loans work in a similar way: The borrower puts up collateral that can be used by the lender to recover their funds if the loan goes into default. However, depending on the type of secured loan, borrowers use the funds for different purposes. Qualifying for one of these loans depends on multiple factors, including your credit history, credit score, income, debts and the item being used as collateral.

Personal loans

With a secured personal loan, the collateral can be any number of items, such as a vehicle you own, cash in a savings account or real estate. You receive a lump sum of money and can use it for many different purposes. You pay the money back in installments (usually monthly).

For example, if you own a car free and clear, you can borrow money against it using a secured personal loan. The lender will first inspect and appraise the vehicle to put a value on it and determine how much you can borrow.

Business loans

Business loans may be backed by business equipment, inventory, savings, real estate and other company assets. Secured business loans can go toward purchasing equipment, vehicles, capital needs, expansion and debt refinancing.

Mortgages

Mortgages are one of the most common forms of secured loans. When you take out a mortgage, the home you are buying is the security for the loan. Mortgage lenders request an appraisal, then lend up to 100% of the purchase price of the home — although most loans require a down payment. If you fail to make payments on the loan, the lender can force the sale of the home through the foreclosure process.

Home equity loans

A home equity loan is a type of second mortgage that lets you borrow money and use your home equity as collateral. You might use the lump sum you get from a home equity loan to make home improvements, consolidate debt, pay for a child’s education, make a large purchase or just about any other purpose. As with a mortgage, failing to pay back the loan could result in foreclosure.

Auto loans

Auto loans are secured loans that cover the purchase of a vehicle. The vehicle serves as collateral for the loan. Failure to make payments can result in the repossession of the vehicle by the lender.

Secured credit cards

A secured credit card works like an unsecured credit card, except that you put a deposit down with the credit card issuer to secure the credit. For example, you might get a secured credit card with a $500 limit if you put down a $500 deposit. Having a secured credit card can help you build or rebuild your credit if you make your payments in full and on time each month.

How to get a secured loan

You can get a secured loan from many types of lenders, including banks, credit unions, specialized lenders and online lenders. To apply for a secured loan, you should be prepared with the following:

• Proof of ID
• Proof of address
• Proof of income
• A list of your current debts
• The collateral you are using (e.g., vehicle details, vehicle title and proof of insurance for an auto loan)

Each lender sets its own qualifications for secured loans, including income, credit score and debt-to-income (DTI) ratio requirements. The application process at each lender may also be slightly different. Before you start looking at lenders, it’s smart to review your credit report to check for any inaccuracies.

How to get a secured loan with bad credit

One of the advantages of secured loans over unsecured loans is you are more likely to be approved with bad credit. The minimum credit score depends on the lender and the type of secured loan you need. Some lenders don’t have a minimum credit score, but keep in mind that having a lower credit score usually translates to paying a higher interest rate.

Credit isn’t the only factor that matters when applying for a secured loan. In many cases, you can still qualify for a loan with a bad credit score as long you have sufficient income, a lower DTI ratio and collateral that meets the lender’s criteria.

How does a secured loan work?

A secured loan helps you access money you need for almost any reason. However, it’s important to understand how they work before you take one out.

Secured loans have more flexible qualifications than unsecured loans.

The lender generally uses the value of the collateral as a significant factor when approving an unsecured loan. Whether it’s a home, car, RV or other possession, lenders are unlikely to give you more than the current appraised value — otherwise, they couldn't recover the full value of the loan.

If you are approved for a secured loan and sign for it, you get funds and start repaying the lender. You'll pay a portion of the principal, or the total borrowed amount, along with interest.

Once you pay off the loan in full plus interest, the lender releases any lien on the collateral. If you fail to make payments, the lender may seize your asset and sell it to get its money back.

Pros and cons

Secured loans offer some key benefits, such as lower interest rates and higher borrowing limits, because they are less risky for lenders. There is one big downside to these loans, though: If you fail to pay back the lender, you could possibly lose a valuable asset, like funds in a savings account, a vehicle or your home.

Bottom line

People use secured loans every day to buy homes and purchase new and used vehicles. You can also get a secured personal loan to use for just about anything. Secured loans have many benefits over unsecured loans, but they also come with greater risk.

Take time to research lenders and offers, and make sure you are comfortable with the terms of the loan so you can borrow what you need and keep a valuable asset in your possession.