How Does a Secured Loan Work?
When you’re applying for financing, the bank only sees a snapshot of who you are. Your recent financial history may not be an accurate measure of your ability to pay back a loan.
A secured loan can help you access financing if you’re having difficulty getting an unsecured loan. But what is a secured loan, and how do they work? Read on to find out!
Secured Loans: The Basics
A secured loan is any type of loan that is backed up by a financial asset. The asset is known as collateral, and if the borrower fails to pay back the loan then the lender takes possession of the collateral. A mortgage is probably the most well-known type of secured loan, where the house is the collateral.
The collateral should be equal in value to the amount of the loan. If the lender has to take the collateral, they’ll be able to recoup the money the borrower owes them either through the sale of the collateral or from the value of owning the collateral.
The use of collateral to secure the loan reduces the risk for the lender. If the borrower can’t repay the loan, the lender has a guaranteed way of getting their money back anyway.
Types of Collateral
The most common types of loan collateral are property and vehicles. The lender will put a lien on the collateral so that they can take legal ownership of the property or car if you don’t make your payments.
If you’ve defaulted on your loan and your collateral was your car, then the lender would start the repossession process to take the car. Similarly, if your home was your collateral and you’re unable to pay the loan, the bank would start the foreclosure process.
There are other types of collateral, especially if the person taking out the loan is a business rather than an individual. Businesses can form what’s called a captive insurance company to help insure against risk. The premiums they pay stay in the captive.
Business owners can then use those funds as a secured loan for business expenses. In this case, the collateral is usually funds or assets related to the business and it is specified when the captive is formed.
Why Choose a Secured Loan?
Even if you have a solid financial footing, a secured loan might give you better interest rates or more favorable terms. The lender takes on less risk with a secured loan, so they are usually willing to offer more to the borrower.
Most secured loan repayment terms are at least two years long and offer fixed payments, meaning every month you pay the same amount. The value of your collateral helps determine how much you can borrow, so a secured loan can also give you access to a larger line of credit than an unsecured loan.
Choose the Loan That’s Right for You
A secured loan can benefit both the lender and the borrower. It gives the borrower access to more favorable terms and a financial tool they may not otherwise qualify for, and it reduces the lender’s risk.
Check out our other finance and money articles for more great tips and information.