When borrowing money for any reason, different types of lending are available. Secured debt is one type of loan that requires the borrower to put up collateral in exchange for immediate money or credit. Collateral is anything that can be offered as security to the lender in exchange for the loan. That way, if the borrower fails to repay the loan for any reason, the lender becomes the legal owner of the collateral and can use it to recoup the money.
Most lenders feel more comfortable when a loan is secured by an asset, and there are benefits for the borrower, too. Lower interest rates, higher borrowing limits, and extended repayment terms often accompany secured loans.
Types of secured loans
So, what type of collateral is needed for secured debt? There are several, common types of secured loans that use collateral like your home, car, and other money or valuables.
Often, the reason for a loan may also be the collateral that secures it. A mortgage is one example of a secured loan, in which the home becomes the collateral that backs the repayment. If you were to default on your mortgage payments, the lender could legally seize the property and sell it to recover the money owed.
A home equity loan is another example of a secured loan that uses your house as collateral. In this case, you could borrow based on home equity, which is the difference between what your home is worth and what is still owed on your mortgage. For example, imagine that you need $20,000 to install a swimming pool. Your home is worth $300,000 and you’ve already paid $150,000 towards its value, so your mortgage lender agrees to a secured loan for the cost of the pool. With your home offered as collateral, you’ll likely receive a low interest rate.
Similarly, an auto loan acts as a secured loan in which the car is collateral that can be repossessed if you fail to make payments. After establishing a certain amount of equity in your car, many people also choose to refinance for a lower interest rate. With an auto-refinance loan, your lender will repay the balance of your original auto loan and replace it with a new loan for more money. You, the borrower, receive the monetary difference and are able to enjoy lower interest payments for the duration of your loan. Your car is considered the collateral if you default on your payments.
Another secured loan involving your car is an auto-title loan, which uses the vehicle title as collateral. Normally, you must own your car for this type of loan. Auto-title loans are considered risky and are usually accompanied by higher interest rates, since your car regularly depreciates in value.
Money and valuables
Anything with value can be used to secure a loan. Sometimes, savings and investment accounts are used as collateral, though it’s important to note that you cannot make withdrawals from the account while loan repayment is in progress. Some lenders may also accept valuables (art, collectibles, or jewelry) as collateral, but this is not the case for most major financial institutions.
Benefits of secured debt
Secured loans offer less risk for lenders and typically include benefits for the borrower, too, like:
- Borrowing with substandard credit: Even if your credit history isn’t ideal, you’re likely to qualify for a secured loan because the collateral lessens the risk involved for your lender. By successfully repaying your loan on time, you’ll have the added benefit of building better credit.
- Lower interest rates: With collateral backing your loan, you’re likely to secure a more reasonable interest rate than those offered with other types of loans.
- Higher borrowing limits: You can typically borrow larger amounts with a secured loan, since the lender is likely to recover their money—either through repayment or the resale of your collateral.
- Extended repayment terms: Secured loans often come with longer repayment terms. For example, a mortgage can typically be repaid over a span of 30 years, since a home appreciates in value and adds to the collateral that backs the loan.
Risks of secured debt
By agreeing to secured debt, you also face certain risks that can include:
- Loss of assets: If you fail to make your payments on time, you could lose your home, car, or savings used as collateral for the loan.
- Credit damage: Defaulting on a loan can also negatively affect your credit score and the possibility of borrowing money in the future.
Borrowing money with a secured loan involves both pros and cons, and as with any financial decision, it’s important to carefully evaluate your options. Read more about unsecured debt to discover other loans that could suit your needs.