What Is a Secured Loan? How It Works and When to Use One

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A secured loan requires the borrower to put up an asset as collateral. Unsecured loans, like credit cards, don’t require collateral.

Since they reduce the lender’s risk, borrowers typically use secured loans to finance large purchases like homes and vehicles, but they can also use them to build credit or consolidate debt.

How Secured Loans Work

When you take out a secured loan, you pledge an asset like a house, vehicle or savings account. This added measure of security reduces the risk they pose to lenders, who can then issue bigger loans with better terms. 

If you default, the lender can seize the collateral and take ownership of the asset. 

Types of Secured Loans

There are several kinds of secured loans, each for different purposes and requiring different collateral. 

Mortgage Loans

Mortgage loans allow borrowers to finance real estate purchases using the property as collateral. If the homeowner defaults, the lender can foreclose on the home and sell it to recoup its losses.

Auto Loans

Auto loans are secured by the vehicle being purchased. Similar to mortgages, the bank can repossess the vehicle if the borrower misses payments. 

Secured Personal Loans

Personal loans don’t finance the purchase of a tangible asset like a house or a car. Therefore, borrowers must use outside assets like CDs or the contents of a savings account to secure a personal loan. They can be used for large purchases, home improvements and debt consolidation. 

Secured Credit Cards

Secured credit cards can be an excellent way to build or repair credit because cardholders can use them to establish a pattern of responsible use and on-time payments.

The card is secured by a deposit. For example, if you put down a deposit of $500, your spending limit on the card is $500.

Pros and Cons of Secured Loans

Before applying for a secured loan, consider the potential benefits and drawbacks. 

Pros

• Lower interest rates than unsecured loans
• Increased borrowing power for bigger loans
• Easier approval for borrowers with shaky credit

Cons

• If you can’t pay, you’ll lose the asset you put up as collateral
• May come with stricter repayment terms
• Some secured loans have application fees or charges for early repayment

How to Apply for a Secured Loan: Step-by-Step Guide

Follow these steps to borrow money with a secured loan.

1. Check your credit score, compare lenders and research loan offers
2. Select your collateral and understand its value
3. Apply for pre-approval, if needed and available
4. Complete the application and submit all necessary documents regarding proof of income and asset ownership
5. Review the loan terms and fees before accepting
6. Make payments on time to avoid forfeiting your home, car or other collateral

When Should You Consider a Secured Loan?

A secured loan might be right for you if: 

• You’re seeking a lower interest rate
• You have poor credit or a limited credit history
• If you need to borrow more than you could with an unsecured loan
• You are confident you can make on-time payments for the life of the loan

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