Definition of Secured Loans
The loans that are backed up by some kind of security or collateral assets of the borrower is known as a secured loan. The concept behind secured loans is that the collateral asset can be used by the bank or other lender for the recovery of the loan amount in case the borrower fails to pay. It is also a way to motivate borrowers to pay the loan within due timeline so that they do not lose their collateral assets and can avoid repossession or foreclosure.
When borrowers go to the bank or lender asking for the loan, the bank will ask what kind of collateral they would like to put as security for the loan in the event they fail to pay the same in the future. And in the future, if borrowers face trouble while paying the loan, the lender would put lien i.e. legal claim over the collateral offered by the borrower.
The lender or bank has the claim over the borrower’s collateral till the time he or she does not pay back the loan. When the loan is fully paid the ownership is transferred from lender to borrower once again. And in case borrowers default with the payment of their loans during the loan term, the lender can sell off the collateral to cover off the losses incurred due to the non-payment of the loans.
Features of Secured Loans
Features of the secured loans are as follows:
- The borrower always pledges something as security or collateral for the secured loans.
- Secured loans are generally taken for the larger amounts.
- Secured loans are offered at a lower rate of interest as the principal is secured due to collateral.
- The asset which is purchased with the loan amount is put up as collateral as well for the loan principle.
Example of Secured Loans
Let us take a very simple and regular example where a borrower goes to the bank and asks for a loan to purchase a house and a car. The lender will ask for the house and car to be put as collateral against the home loan and car loan. And in return lender promises to provide the loan at a lower rate of interest than usual. The borrower will accept the offer and the loan will be considered as a secured loan due to the collateral that the borrower put up to secure or back up the loan.
Types of Secured Loans
There are various types of secured loans in the market that are offered by banks and other lenders. The major ones and most commonly used are discussed as below:
- Home loans or mortgage: The home loans or mortgage tops the list of secured loans. In mortgage loans, borrowers put up their house property as collateral to the loan. And in case the borrower fails to pay the loan, the house property as collateral will go into foreclosure and the borrower will lose the home.
- Vehicle or auto loans: As the name suggests, here vehicle purchased is put up as collateral by the borrowers. Common types of vehicle loans are auto loans, car loans, boats, bikes, and even aeroplanes. The procedure is the same as home loans, i.e. in case of non-payment, the lender will sell off the collateral to cover the losses incurred.
- Secured credit card loans: In this type of loan borrower has to put up the cash deposits as collateral for the loans against the credit card. If in the future, the borrower is unable to pay the monthly credit card bill, the cash deposit can be applied against the same.
What Can be Used as Collateral for Secured Loans?
Borrowers put different kinds of assets as collateral, lenders generally prefer the assets that are liquid in nature i.e. the assets that can be easily sold off in the market. But any assets which are allowed per the law of the land can be put as collateral against the secured loans. Some of the assets that are commonly used as collateral are mentioned as below:
- Home, house property, or real estate.
- Bank accounts, certificates of deposits, money market accounts, etc.
- Cars, auto, trucks, bike, boats, airplanes.
- Share certificate, mutual funds, Insurance policies, bonds.
- Gold, high-end collectibles, valuables.
Secured Loan Interest Rates
As mentioned earlier as well, interest rates on secured loans are generally lower than unsecured loans. The reason behind a lower rate of interest is the fact that the principle is already secured by the collateral put up by the borrower for securing the loan. But apart from this, there are other factors as well that impacts the interest rates of the secured loans which are mentioned below:
- Borrowers with a high credit score will get a lower rate of interest on secured loans in comparison to borrowers with a low credit score.
- If the borrower is making a hefty down payment for the loan, the interest rate will be lower than the loans in which there is a lesser or minimal down payment.
- If the term of the loan is shorter, the interest and overall cost will also be lower.
- Interest rates also get impacted by the type of interest rate chosen by the borrower i.e. fixed or variable type.
The benefits are as follows:
- Secured loans come with a lower rate of interest as the principle of the loan is backed up with collateral.
- With secured loans, borrowers can borrow a larger amount of the loan.
- The term of the loan can be longer like ten or twenty years which leads to low monthly installments.
- Approval on these kinds of less risky loans from the lender’s side is easy and immediate.
The disadvantages are as follows:
- In case, borrowers face trouble paying the loans, they may have to lose the collateral.
- In case of default, the borrower’s credit history can be seriously damaged which will lead to a higher rate of interest on any future loans.
- The upfront fees are sometimes very high which leads to high initial costs.
- Usually, the borrower needs to arrange for the down payment amount for getting the secured loans.
Secured loans are backed up by collateral, which can be any asset permitted by law like house property, cars, bank accounts, etc. It is an excellent way of raising finance by individual borrowers. And good things like reduced interest rates, easy monthly installments and longer-term increases its value.
This is a guide to Secured Loans. Here we also discuss the definition and types of secured loans along with benefits and disadvantages. You may also have a look at the following articles to learn more –