A Beginner’s Guide to Secured Loans

Whether you’re looking to purchase your first home, finance a car or leverage equity in order to renovate your property, a secured loan is the main type of borrowing you’ll run into.

Secured loans open the doors to large loan amounts with low interest rates, but they also come with the biggest possible risks, which is why we’ll guide you through the basics of these borrowing options, while also providing you with all the possible advantages and disadvantages when it comes to them.

How Secured Loans Work

The basis of secured loans revolves around a trade-off of you pledging an asset in order to gain access to financing. The most commonly used assets to secure these loans are a house, a car, a savings account or even investment securities.

For example, if you take out a mortgage to buy your house, the home itself serves as collateral, meaning that the lender can initiate foreclosure proceedings and sell the property if you fall behind on loan payments and default on the loan.

The fact that having a collateral reduces the potential losses to lenders this way means that secured loans can be approved to borrowers with lower credit scores or less income than it would be required for unsecured loans.

Due to the “security” of these loans, they also come with more favorable terms, including higher borrowing limits, lower interest rates and longer repayment terms.

Common Types of Secured Loans

There is a wide variety of secured loans available to borrowers, tailored to different needs and circumstances. The most common and prevalent types of secured loans are:

Mortgage Loans

Mortgages are easily the most well-known type of a secured loan. Used to purchase real estate, mortgage loans usually range from 15 to 30 years, and are secured by the asset which then serves as collateral. 

Due to the size of the loan and the value of the asset, lenders usually conduct a rigorous underwriting process, including credit checks, income verification, and an appraisal of the home.

If you want to pursue this type of loan, you can check out our dedicated page on the best mortgage lenders on the market today.

Auto Loans

The second most-common type of secured loans are auto loans, through which you finance a purchase of a new vehicle.

Auto loans usually have shorter terms, ranging from 3 to 7 years, and similar to mortgages, the lender can repossess your car if you default on the loan, often without court approval, making these loans much more aggressively enforced than some other types.

The interest rates on auto loans vary depending on credit history, down payment size, and vehicle age. 

New car loans usually offer better rates than those for used vehicles, but borrowers should still be mindful of depreciation and the total interest cost over time. 

If you want to learn more about auto loans and the current offers, you can consult our page comparing different auto loan lenders.

Home Equity Loans

When you build equity in your property, you can take out a home equity loan which taps into it, with the home itself serving as collateral.

Home equity loans are usually taken out for those larger, unexpected expenses like medical bills or home renovations, as well as for purposes of debt consolidation, as they’re structured as lump-sum, fixed-rate installment loans.

Still, these loans do use your home as collateral, and there is a real risk of foreclosure with them, even if your original mortgage is still active, which is why lenders will usually let you borrow only up to 75-85% of your home’s appraised value, minus the remaining mortgage balance.

Our page on the best home equity loans can help you parse through the current offers if you’re considering this type of a secured loan for yourself.

Home Equity Line of Credit (HELOC)

A HELOC works similarly to a home equity loan, with the main difference being that it operates more like a credit card, providing you a revolving line of credit based on the equity you built up in your home.

HELOCs are therefore suited more to those ongoing expenses like tuition or phased renovation projects, allowing you to borrow, repay and re-borrow during a set draw period, which usually lasts between 5 to 10 years, after which the loan enters a repayment phase, which itself lasts between 10 to 20 years.

Most HELOCs have variable interest rates, meaning your monthly payments can fluctuate. Like home equity loans, HELOCs are secured by your property, so defaulting can result in foreclosure.

Secured Personal Loans

Secured personal loans are used for a wide variety of purposes, from debt consolidation all the way to funding major purchases or covering emergency expenses, and are backed by assets such as cash savings, certificates of deposit (CDs), or personal property.

They are naturally easier to qualify for than unsecured personal loans, and also come with more favorable terms and lower interest rates, but the risks and conditions vary both by lender and the type of asset you put up as collateral. 

For example, using a CD as security can lead to having your account frozen until the loan is repaid.

Secured Credit Cards

Another popular type of a secured loan are secured credit cards, designed to help build or rebuild a person’s credit score.

These cards function like standard credit cards, but require you to make a refundable security deposit, ranging from a few hundred to a few thousand dollars, which then determines your credit limit.

If you then pay your bill on time and in full each month, your credit score will improve over time, and after a period of responsible use, many card issuers will allow you to upgrade to an unsecured card, while also giving you back your initial security deposit.

Life Insurance Loans

If you already have a universal or whole life insurance policy, you have an option to borrow against its accumulated cash value through a life insurance loan.

These loans often do not have a repayment schedule, nor do they require a credit check, as they function by deducting any unpaid balances from the death benefit that would be paid to your beneficiaries when you pass away.

What’s more, interest will continue to accrue over time, so any unpaid debts can significantly reduce the insurance payout to your heirs, which is why these loans should only be used in emergency situations.

Share-Secured Loans

Also known as savings-secured loans, these loans are a low-risk option, most commonly used by borrowers looking to start building their credit history.

Share-secured loans are backed by funds in your savings account or CD, and because your funds are held by the lender, interest rates on them are much more favorable than on unsecured personal loans.

Car Title Loans

Car title loans are a high-risk option, as they attract borrowers with poor credit due to the fact that they usually do not require credit checks. The risk here comes in the extremely high interest rates, often exceeding 300% APR, which can easily lead to a default on the loan and the repossession of your vehicle.

Pawnshop Loans

Pawnshop loans offer fast, small-dollar financing with no credit check. 

You simply bring in a valuable item like a piece of jewelry or an electronic device, and receive a loan based on its appraised value. 

The pawnshop holds the item until the loan (plus fees and interest) is repaid, typically within 30 to 90 days. If you do not manage to repay the loan, your item is sold.

Business Secured Loans

Secured loans can also be taken out by businesses, as many companies nowadays utilize them to finance equipment purchases or to gain working capital.

Business secured loans are secured by your company’s assets, including inventory, machinery, commercial real estate or accounts receivable.

They also often require you as a business owner to sign a personal guarantee, making you personally liable for the debt in the event of default, even if your business shuts down.

Secured Loans vs. Unsecured Loans

To better understand secured loans, it’s important to compare them with their unsecured counterparts.

As you can see, unsecured loans usually offer faster funding and come with greater flexibility when it comes to terms, but they also require a stronger credit profile.

Final Thoughts

Secured loans come in many different forms, offering an affordable, but often risky option to finance everything from emergency expenses to long-term financial goals.

The always-present possibility of losing your collateral is something that must be considered, however, and it's best to first weigh all of your options before committing to one of these loans. 

If used responsibly, a secured loan can help you take control of your finances without compromising your financial stability.