Many kinds of loans exist, and you might get several of them over your lifetime. You’ll probably have a mortgage, at least one credit card, an auto loan, and maybe a student loan. You might take out a home equity loan or a personal loan. So you can better make use of these financial tools when you need them, you should understand the differences in these types of loans. One big differentiator is whether loans are secured or unsecured.
Secured Loan Definition
What is a secured loan? A secured loan is one that is backed — that is, secured — by something tangible. This item is the loan’s collateral, and you basically pledge the item in exchange for the loan. The loan agreement will state that the lender gets to reclaim the collateral if you default on the loan.
Because the lender has some protection against losing the money he loaned you, a secured loan will often have a lower interest rate than an unsecured loan. Someone who might not qualify for an unsecured loan due to poor credit might be more easily able to get a secured loan.
Also See: What Is an Unsecured Loan?
Common Secured Loans
The two most common types of secured loans are mortgages, including home equity loans, and auto loans. When you take out a loan to buy a house or a car, the lender puts a lien against the property. This means that the lender has an ownership interest in the house or the car, and the lender can sell the property to satisfy the loan if you fail to comply with the loan’s terms.
A mortgage is a good secured loan example. The bank that gives you the mortgage to buy the house will be listed as a lienholder on your property. If you don’t pay your mortgage as agreed, the bank can foreclose on the house to recoup the money that was loaned you.
You can also get a secured personal loan or credit card. These loans are usually secured by a deposit or the money you hold in a savings account. They can be used to build your credit history or to pay for emergency expenses without depleting your savings.
Who Should Get a Secured Loan?
If you need a loan for something other than buying a house or a car, you might have a choice between applying for a secured or an unsecured loan. Here are a few things to consider if you’re trying to decide; if these are terms that work for you, you might want to get a secured loan:
- Interest rates on secured loans are usually lower. Because the lender has some recourse if you default, the interest rates on secured loans are typically lower than rates on unsecured loans. This assumes your credit rating is adequate to qualify for an unsecured loan. For example, the interest rate on a car loan at Navy Federal Credit Union was between 1.99 percent and 5.29 percent as of Oct. 26, 2017, depending on the length of the loan and whether the car is new or used. The interest rates on credit cards, which are unsecured, varied between 9.99 percent and 18 percent at the same time.
- A secured loan can help you build credit. If you handle your debt responsibly, you’ll be able to build your credit with it. You might not qualify for an unsecured loan or credit card if you have poor credit or no credit at all. By depositing money with the credit card company or pledging collateral like your savings account to the bank, you might be able to get the loan or credit card. Then you can build up your credit to the point where you can get an unsecured loan if you make timely payments.
- You’ll lose the collateral you put up to secure the loan if you default on a secured loan. This means that people who default on mortgages or home equity loan, or personal loans that have placed their houses as collateral, could lose their homes.
A secured loan is for you if you need the lower interest rate that a secured loan provides, or if you cannot get a loan without putting up collateral. Otherwise, you might want to get an unsecured loan so you don’t put your home or other collateral at risk.