What to know when considering a secured personal loan

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In a Nutshell

When you take out a secured loan, you give the lender a legal interest in some of your assets, making them “collateral.” If you don’t repay the loan, the lender can take the collateral to recover the unpaid funds. Since there’s less risk to lenders, secured loans are easier to qualify for, even if you don’t have good credit — but some of these loans may end up being costly for borrowers who aren’t careful.

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When you borrow money, lenders want to do whatever possible to make sure the debt will be repaid.

In many cases, lenders have no assurances you’ll pay them back beyond your promise to repay. Debt guaranteed by nothing other than your word is called “unsecured.” Lenders making an unsecured loan look at your credit history and scores to determine how likely it is you’ll actually keep your word. If you’re deemed a risky borrower, you may be denied a loan or charged a higher interest rate.

In other cases, repayment isn’t just guaranteed by your promise — it’s guaranteed by collateral. Loans guaranteed by collateral are known as “secured” loans. With a secured loan, you give lenders an ownership interest in some of your property. The property guaranteeing the loan is the collateral, and lenders can take it if you don’t pay as promised.

Because lenders can recoup borrowed funds by seizing collateral, it’s not as risky for them to lend — so it can be easier to get approved even with no credit or bad credit.

There are different kinds of secured loans. Two of the most common and well known are mortgages and auto loans, in which the property you purchase with the loan also serves as the collateral. Another type of secured debt, secured credit cards, provides you with a line of credit typically equal to the value of funds you deposit with the lender; those funds serve as collateral.

You can also get a secured personal loan that can be used for almost any purpose. Read on to find out exactly how secured loans work, where you can get one, and what kind of collateral you can use to secure them.

How do secured personal loans work?

When you take out a secured personal loan, you’ll pledge assets that will act as collateral to secure the loan.

When you take out a secured loan, you’re giving the lender a right to claim the asset as payment for the loan. That claim to your property is called a lien. The lien stays in place until you repay the loan. If you pay the loan back, the lender releases the lien. If you don’t, the lender can seize the collateral. The specific point at which a lender will take the collateral will vary based on your loan contract, the type of secured loan and your state laws. But in some cases, lenders can act to seize property as soon as you fall behind on payments.

What kinds of assets can work as collateral?

In order to qualify for a secured personal loan, you need something of value to pledge to the lender as collateral. Some of the assets you own that could qualify as collateral include the following:

  • A paid-off vehicle
  • Money in a savings account
  • Certificates of deposit
  • Valuable property, such as your car or house

Lenders want to ensure your collateral is valuable enough to guarantee the loan will be repaid — either via payments you make or the collateral you put up. This may mean the property needs to be appraised to determine its worth.

Usually, you’ll keep physical control of the property used as collateral even though the lender has a legal interest in it. If you’ve used your car as collateral, this means you can still drive it. But there can be restrictions to protect the lender, such as requiring you to maintain collision coverage on a car or to maintain a certain minimum balance in a bank account serving as collateral.

Remember, collateral is at risk with a secured personal loan

When you take out a secured personal loan, you risk losing the assets you pledged as collateral. If you don’t repay the loan, you could end up losing your vehicle, home, money or other property that’s guaranteeing the loan.

The process of seizing collateral varies depending on the type of collateral and your state laws. Your loan contract should outline exactly when lenders can take the collateral and the process they must follow to seize your assets. In some cases, they can simply take the property serving as collateral — even without providing advance notice — so you should read your loan agreement very carefully to understand your protections and rights.

When a lender seizes property for nonpayment, it will likely sell it and use the proceeds to pay off your debt and cover any costs associated with recouping its losses.

You’ll only get money from that sale after the lender has been paid in full. If the sale doesn’t generate enough to repay what you owe, the lender might try to collect the difference from you.

Where can you get a secured personal loan?

Secured personal loans can be obtained from banks, credit unions and online lenders. To obtain a secured personal loan, shop around and compare interest charges, collateral requirements and repayment terms.

If you’re looking into a car title loan or a pawn shop loan, consider other options first. These loans can be very costly, with lenders usually charging high interest and a host of fees.

How to get a secured personal loan

If you’ve decided to borrow using a secured personal loan, you’ll want to compare loan terms among different lenders. There are several things to consider when shopping around.

  • The interest rate: How much will you pay for the privilege of borrowing money? Some secured loans, such as car title loans, are targeted to borrowers with bad or little credit and no other options. These loans can be very expensive. On the other hand, some secured loans, such as home equity loans, may have rates lower than those of other types of loans.
  • The loan term: How long do you have to repay the loan? A shorter repayment period means higher monthly payments, but you’ll pay less interest over time because your debt will be paid back more quickly.
  • Fees associated with the loan: You may need to pay an application fee, a loan origination fee, monthly fees and the costs of an appraisal to determine the value of your property. Car title loans, in particular, tend to have very high fees, which is part of what makes them a bad option for many borrowers.
  • The monthly payment: Make sure you don’t take out a secured loan that isn’t affordable on a monthly basis. Not meeting your monthly payments could mean you’ll lose the collateral.
  • The collateral requirements: What property do you own that the lender will accept as collateral? Some lenders only accept a paid-off vehicle, while others could be willing to accept a savings account.
  • The time it takes to obtain the money: In certain circumstances, it may be faster to obtain a secured loan than an unsecured loan. For example, Wells Fargo provides that if you use your Wells Fargo CD or savings account to secure the loan you could get the funds by the next business day.
  • The amount you can borrow: Find out the loan minimum and maximums.

Once you’ve found a lender offering a loan you think you can qualify for with reasonable terms, you can submit an application. If your application is approved, you’ll receive the borrowed funds and begin loan repayment.

Bottom line: Is a secured personal loan right for you?

For many borrowers, a secured personal loan isn’t their first choice. Instead, borrowers may decide to apply for a secured personal loan if they can’t qualify for an unsecured loan, need money right away, or can get a lower interest rate than with an unsecured loan.

That doesn’t mean secured personal loans are necessarily a worse option. These terms often work well for borrowers who can make their monthly payments on a steady schedule. Borrowers with less-stellar credit histories can also build credit by borrowing and repaying the loan responsibly over time.

However, there are many unscrupulous lenders targeting bad-credit borrowers with secured loans that are very costly. For instance, car title loans can come with monthly fees and interest as high as 25% of the borrowed amount, for an APR of roughly 300%. Before borrowing, research your loan terms and lender carefully, and stick with reputable lenders.

Most crucially, make certain you’re 100% confident you can repay the loan. If you’re not, you’re taking the chance of losing your money or property, as well as taking a hit to your credit.

About the author: Christy Rakoczy Bieber is a full-time personal finance and legal writer. She is a graduate of UCLA School of Law and the University of Rochester. Christy was previously a college teacher… Read more.