A secured loan is one that is backed by assets that give the lender security, like a home or vehicle. Mortgages and car loans are typical examples of this type of loan. By pledging assets, borrowers minimize the lender’s risk, which can result in reduced interest rates and financing for major purchases like homes or vehicles. If, however, you fail to repay the loan, the lender has the right to take possession of the collateral to cover their loss. While secured loans come with advantages, such as flexible borrowing options, they also carry risks, so it is essential to thoroughly understand the terms and potential consequences before borrowing.
How Does a Secured Loan Work?
A secured loan is a form of borrowing backed by collateral, which may include tangible assets like a car or house, or financial assets such as stocks or bonds. These loans are often used for significant purchases, like purchasing a home through a mortgage or acquiring a car via an auto loan. In most cases, the asset obtained with the loan serves as collateral.
Besides mortgages and auto loans, secured personal loans are also an option. These loans operate similarly to unsecured personal loans but necessitate collateral, making them accessible for individuals with lower credit scores and often offering reduced interest rates.
However, failing to repay a secured loan can lead to severe consequences. Missing payments can result in the lender placing a claim on the collateral and seizing it to recoup losses. For example, in the case of a mortgage, this process is known as foreclosure. Given these risks, it is important to fully comprehend the terms and implications before opting for a secured loan.
The following are a few typical forms of secured loans:
- Mortgages: These include home equity loans and Home Equity Lines of Credit (HELOCs), typically backed by your home.
- Auto Loans: Used to finance cars, boats, motorcycles, or other vehicles, with the vehicle itself serving as collateral.
- Secured Personal Loans: These offer flexible borrowing options, requiring assets like savings or valuable items as collateral.
- Secured Credit Cards: Backed by a cash deposit, these are excellent for building or improving credit.
Common types of collateral
The collateral required usually depends on the loan’s purpose—whether personal or business-related. Some typical examples of collateral include:
- Real estate, such as a home or property equity
- Cash accounts, including savings accounts and certificates of deposit
- Vehicles, like cars, boats, or recreational vehicles
- Machinery and equipment for business use
- Investments, including bonds and stocks
- Insurance policies with a cash value
- Collectibles and valuables, such jewellery or artwork
Each type of collateral comes with unique advantages and risks, so it is crucial to choose wisely based on your financial situation.
Advantages of secured loans
Access to larger sums of money is made possible by secured loans. Since the loan is guaranteed by personal or business assets, the lender faces reduced risk. This lower risk often leads to favorable interest rates and extended repayment terms, making the loan more affordable.
Additionally, secured loans can be a viable option for businesses with a poor credit history, as long as they have valuable assets to offer as collateral.
Disadvantages of secured loans
While secured loans typically come with lower interest rates, they require borrowers to pledge assets as collateral to minimize the lender’s risk in case of non-repayment.
Some lenders may also charge upfront fees, increasing the overall borrowing cost. To better understand the total expense, including any additional charges, it’s helpful to use a business loan calculator to evaluate the quotes you receive.
Pros and cons of secured loans
Secured loans provide significant benefits, such as lower interest rates, but they also involve certain risks.
Pros:
- Easier qualifying standards: Secured loans may be accessible to those with lower credit scores or limited income.
- Larger borrowing limits: Borrowers often qualify for higher loan amounts compared to unsecured loans.
- Reduced mean rates: Generally speaking, secured loans have lower interest rates than unsecured ones.
Cons:
- Risk of losing your asset: If the loan remains unpaid, lenders can seize the asset used as collateral.
- Your asset must qualify: Lenders will evaluate the value of the asset (home, car, etc.) to determine if it sufficiently supports the loan.
- More involved application: Secured loans often require additional documentation and can take longer to process than unsecured loans.
Secured loan benefits
Secured loans generally come with reduced rates and fees, as they pose less risk to lenders. In contrast, interest rates on unsecured loans can reach 36%, particularly for customers with bad credit.
Secured loans also allow borrowers to access larger loan amounts, often exceeding the limits of unsecured loans, which typically cap at $50,000 or less. Furthermore, secured loans often feature longer repayment terms, such as mortgages that may extend up to 30 years. Unsecured loans, on the other hand, usually have shorter terms, ranging from one to seven years.
Is a secured loan right for your business?
Secured loans can be used for various purposes, such as purchasing new property or equipment, upgrading facilities, or even acquiring a competitor.
If you or your shareholders have assets to offer as collateral, a secured loan might be a suitable choice for your business. While repayment terms may be extended, secured loans typically feature favorable interest rates, reducing both monthly payments and overall borrowing costs.
However, secured loans might not be available in certain locations, such as Northern Ireland or Scotland. In these cases, unsecured loans may provide a more practical alternative.
Secured loans and default
If you fail to repay a secured loan, the lender may initiate repossession of the asset tied to the loan. This process can take several months, and during that time, the lender may offer various options to assist you if you’re experiencing financial difficulties.
However, if the asset is repossessed or foreclosed upon and doesn’t sell for enough to cover the loan, you could still owe the remaining balance. In some states, the lender may take legal action and pursue a deficiency judgment, which is recorded publicly and can affect your credit report for up to seven years.
Assets like homes, land, and business property typically take longer to sell, giving you additional time to resolve your payments. In certain states, the lender must go to court to foreclose, which could take more than a year. In other states, the foreclosure process may not require court involvement and can be resolved in as little as two months after the lender provides notice.
What to do if you can’t repay a secured loan
If you’re struggling to repay a secured loan, there are several actions you can take to manage the situation:
- Contact the lender: Reach out to your lender to discuss potential solutions. They might be willing to modify the terms of your loan, such as adjusting the payment schedule, extending the repayment term, or temporarily deferring payments.
- Seek financial help: Consider consulting a certified consumer credit counseling agency, such as those accredited by the National Foundation for Credit Counseling (NFCC) or the Financial Counseling Association of America (FCAA). You might also find assistance from a U.S. Department of Housing and Urban Development (HUD)-approved housing counselor, who can help negotiate loan modifications with your mortgage provider.
- Prioritize your bills: Focus on paying secured debts that are essential to your daily life. For instance, if you have to choose between paying your credit card bill or your car loan, prioritize the car payment. A vehicle is crucial for transportation to work or to fulfill family needs, while credit cards typically aren’t as critical for basic daily needs.
Secured vs unsecured loan requirements
At Fleximize, we provide both secured and unsecured loans, giving you the flexibility to choose the right financing option for your business. Each loan type comes with its own set of requirements and features, which you can compare below:
| Requirement | Unsecured Finance | Secured Finance |
| Business type | Limited company, LLP, non-limited partnerships, sole traders | Limited company, LLP |
| Location | Based in the UK | Based in England or Wales |
| Trading history | 6 months + | 6 months + |
| Monthly turnover | £5,000 + | £5,000 + |
Compare unsecured and secured loan features:
| Feature | Unsecured Finance | Secured Finance |
| Loan amount available | Up to £250,000 for limited companies and LLPs.From £25,000 for non-limited partnerships and sole traders. | Up to £500,000. |
| Eligible assets | – | Assets such as real estate, machinery, vehicles, inventory, receivables, and intellectual property. |
| Personal Guarantee | May be required for limited companies and LLPs. | Could be necessary for limited companies and LLPs. |
| Interest rates | 0.9% + | 0.9% + |
| Fees | No extra charges or penalties for early repayment. | No additional fees or early repayment fees charged. |
| Repayment terms | 3 – 36 months | 3 – 60 months |
The Bottom Line
A secured loan can be a helpful tool for financing various goals, such as purchasing a home, car, or covering major expenses. However, these loans, backed by collateral, come with significant risks. It’s essential for borrowers to carefully consider both the benefits and risks before committing to a secured loan. Ensure you have a solid plan and budget in place to repay the loan.
While secured loans may offer lower interest rates, an unsecured loan could be a better option if you want to avoid risking your property. Additionally, you can explore other ways to lower personal loan interest rates, such as reviewing your credit report and credit score for free via services like Experian.
Improving your credit score before applying for a loan can be beneficial. A higher score opens up more borrowing options and may help secure a lower interest rate, saving you money in the long run.
FAQS
How does a secured loan work?
A secured loan requires you to offer something valuable, such as property or equipment, as collateral. If you fail to make payments, the lender has the right to take possession of the collateral to recover the amount owed. Since these loans are less risky for lenders, they typically come with lower interest rates compared to unsecured loans.
Is an unsecured loan good or bad?
An unsecured loan can have both benefits and drawbacks, depending on your circumstances. The advantage is that you don’t need to provide collateral, but the downside is that the interest rates tend to be higher. Additionally, failing to repay the loan can negatively impact your credit score.
What distinguishes a secured loan from an unsecured loan?
The key difference between secured and unsecured loans is that secured loans require collateral, such as property, while unsecured loans do not. Secured loans generally come with lower interest rates due to the collateral, but unsecured loans are riskier for the lender, which may result in higher interest rates.
Is an unsecured loan a debt?
Yes, an unsecured loan is a type of debt where you borrow money without providing collateral. You are required to repay the borrowed amount along with interest. Since there is no collateral, the lender depends on your commitment to repay the loan, and they may take legal action if you fail to do so.
Why is an unsecured loan risky?
An unsecured loan carries more risk for lenders since it doesn’t involve any collateral. If the borrower defaults, the lender has no assets to claim in order to recover the debt, which results in higher interest rates.
