Certain types of loans, like mortgages , are always secured loans. But with other types of debt, you may have the option of choosing between secured and unsecured options.
Which type of loan is best? In short, it really depends on your specific situation. In some cases, a secured loan could be a smart choice, but it could also put you at higher risk. Here's what you need to know.
What is a secured loan?
A secured loan is a type of loan that is guaranteed by collateral that you own. If a borrower defaults on a secured loan, the lender can seize the collateral to minimize its losses. Here are a few common examples of secured loans:
- Mortgages : Secured by your home or property
- Auto loans : Secured by your vehicle
- Secured credit cards : Typically secured by a deposit
- Secured personal loans : Could be secured by a variety of financial assets
These are just a few examples of secured loans. But any time you finance the purchase of a physical item, whether it be a couch or a boat, there's a strong chance that you have a secured loan. In each case, the lender has the right to repossess the collateral (if you miss a payment) until the loan has been fully repaid.
What can be used as collateral for a secured personal loan?
With car loans or mortgages, the item that you purchase is also the collateral. But with personal loans , you receive cash instead of a physical asset. For this reason, most personal loans are unsecured.
However, there are ways for a borrower to secure a personal loan. Here are a few assets that a lender may accept as collateral for a personal loan:
- Home equity
- Savings account of CD
- Vehicle title
- Insurance policies
- Stocks, bonds, and other equities
- Jewelry
- Precious metals
- Collectibles
What are the benefits and drawbacks of a secured loan?
Secured loans are less risky for the lender. Because of this, they may be willing to offer you better terms for a secured loan than an unsecured one.
Choosing a secured loan could land you a lower interest rate, a higher borrowing limit, or better repayment terms. And if you have a limited or damaged credit history, pledging an asset as collateral could help you receive loan approval.
But while secured loans could provide more borrowing options or more attractive terms, they also represent a higher risk for you as the borrower. If you default on the loan, the bank can take back your home, car, jewelry, or whatever else was used as collateral.
It's also important to point out that not all secured personal loans offer better terms or rates than their unsecured counterparts. In fact, secured loans that are targeted to borrowers with bad credit (like title loans or pawn shop loans) often charge expensive fees and high interest rates.
Should you pay off unsecured debt with a secured loan?
If you're dealing with crushing credit card debt, you may be tempted to take out a second mortgage or a title loan on your paid-off vehicle to consolidate your debt at a lower interest rate.
On the surface this may seem like a sound financial decision. But, in reality, it's a very dangerous move because you'd be moving an unsecured form of debt over to a secured debt.
While dealing with credit card collection agencies can be overwhelming, they can't take away your personal property without obtaining a court judgment. But once you transition to a secured loan, your collateral is now at risk.
Is taking out a secured loan a good idea?
In some cases, taking out a secured loan could be a smart decision. For example, your bank may offer you a better interest rate and terms on a home equity loan than an unsecured loan. Also, a secured loan could help you rebuild a damaged credit score.
On the other hand, some secured loans aimed at borrowers with low credit scores, like vehicle title loans, can charge outrageous rates and fees. Before you take out a title loan, make sure you've explored all your other borrowing options , like Payday Alternative Loans (PAL), which are offered at credit unions.
As with any loan, you need to make sure that you can truly afford your monthly payments on a secured loan. And be sure to do your research and compare lenders before choosing the right secured loan for you.
