Secured personal loans: What you need to know

If you need to borrow money, one of the more popular options is to take out a secured loan. With this form of funding, the borrower uses an asset as collateral to back up the loan.

A variety of items can be used to secure a loan, including real estate, vehicles, stocks, mutual funds or an insurance policy. Lenders most often look for assets that are easily sold and worth about the same as the amount being borrowed. A lien is put on the asset until the loan is paid in full. If the loan isn’t paid, the lender can take the asset as a form of payment.

Why you might want a secured loan

The most common types of secured loans are mortgages, vehicle loans, personal loans and secured credit cards. How you plan to use the funds can impact what you use as collateral. In the case of a mortgage or vehicle loan, it makes sense that a house or car will be used as collateral. With a secured personal loan, the collateral could be an investment, such as a certificate of deposit or mutual fund, or an insurance policy.

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A secured credit card, on the other hand, requires a cash deposit as collateral. Consumers who are trying to establish a credit history may use this type of loan to build up their credit score.

Secured versus unsecured personal loans

While a secured loan uses collateral, other loans can be unsecured. This means that they aren’t backed by anything. If you default on an unsecured loan, the lender cannot take any of your personal assets, but it can affect your credit score, making it difficult to get approved for other types of credit in the future. The most common forms of unsecured loans are credit cards, student loans and personal loans.

Where to apply

Banks, credit unions and online lenders offer secured loans. Rates and requirements vary, so it’s a good idea to shop around before signing on the bottom line. For example, banks often lend to consumers with higher credit scores, while credit unions often require borrowers to be members.

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The pros and cons of secured personal loans

Taking out a secured loan has several advantages. First, it’s often easier to obtain this type of funding because you’re putting down collateral. Since lenders won’t assume as much risk, they often offer lower interest rates as well as offer higher loan amounts. And borrowers with lower credit scores may find it easier to qualify for a secured loan since lenders are more willing to loan money that’s protected with an asset.

There are downsides, however. It can take longer to get approved for a secured loan because the borrower will need to properly value the collateral. Also, if you fail to make your payments, your asset can be repossessed—an event that can stay on your credit report for up to seven years. In addition, if the asset doesn’t sell for the amount of your loan, the lender can demand payment on the balance owed.

The bottom line

Getting a secured loan can be an effective way to borrow money, but be sure you understand its terms and conditions. As with any loan, the best plan is to have a strong strategy for repayment before you sign the paperwork. With a secured loan, this means getting the money you need and keeping your assets in the process.