You may know at least one person in your family or social circle who has taken some kind of loan, whether for education, business or something personal like buying a car or house. If you are considering or might consider getting one, you should know there are two major types of loans – secured and unsecured. 

The former type of loan is a financial tool that allows you to access funds by pledging collateral, such as property, vehicles, or savings, as security. You can obtain secured loans from banks, credit unions or online lenders. 

There are several benefits to opting for a secured loan such as lower interest rates, higher loan limits, longer loan terms and more. There are also pros to taking an unsecured loan, but more on that later.

To help you make informed financial decisions, we have broken down how secured loans work, the types available, and the steps to obtain one.

Also Read: Didn’t Get Student Loan Forgiveness? Other Alternatives To Tackle Student Debt – Vola

What You Should Know Before Applying for a Secured Loan?

Here are important questions you need to find answers to before applying for a secured loan. 

1. Are there any processing fees (origination fees) or prepayment penalties?
2. What can I use as collateral? And how much loan can I get against the asset?
3. What are the eligibility criteria (like income, credit score, etc) for a loan? 
4. What is my interest rate and is it fixed or variable?
5. What is the annual percentage rate (APR) for the loan?

Once you have an overview of your loan needs, repayment duration, and interest rates, you can start comparing loan rates and terms offered by different lenders. You can do so through various means – lender websites, credible financial experts, and online secured loan calculators. 

How Do Secured Personal Loans Work?

There are various types of personal loans you take from a bank. These include mortgage loans, bad credit loans, life insurance loans, secured credit cards, vehicle loans, pawnshop loans and more. 

For collaterals, you can use your assets like a paid-off vehicle, an investment account including a certificate of deposit or money market, a house, a trailer, fine art, or jewellery. Once you submit the collateral, you cannot sell or liquidate the same asset without prior permission. 

If you want a secured credit card, you can offer cash as collateral. When you deposit thousands of dollars to the lender, they will use this as your credit limit. 

In the case of a secured business loan, you might have to sign a personal guarantee. For instance, if you default, the lender can sue you for the liabilities. 

The lender will examine your financial behaviours, expenses, income and past debts. The lender will take a few days or weeks to assess the validity and value of your assets before processing the amount in your account. 

What Happens if You Can’t Repay a Secured Personal Loan?

In the majority of cases, the lender will seize your asset if you fail to repay your secured loan. If the sale of your collateral covers the outstanding costs, you are in the clear. If the lender still faces loss, they might pursue you for deficiency balance depending on your state law. 

Also Read: What You Need to Know About Delinquency and Not Paying Student Loans 

Secured vs. Unsecured Personal Loans

In simple terms, secured and unsecured loans have the same purpose – to give you a lump sum loan and get back the amount with interest value in instalments till the balance is zero. 

A major difference between secured and unsecured loans is that the former requires collateral such as a home, car, or savings, to back the loan, offering lenders a safety net in case of default. Most secured loans have lower and fixed interest rates, However, if you have poor credit, the bank might charge you higher interest rates. 

In contrast, unsecured loans don’t require collateral and are based solely on the borrower’s creditworthiness and ability to repay. As a result, unsecured loans typically come with higher interest rates, lower borrowing amounts, and stricter credit requirements. 

Secured loans can be a practical solution for those seeking substantial financing at competitive terms. You can leverage your collaterals to gain access to funds while lenders mitigate risk. 

However, it’s crucial that you first assess your financial situation and understand the risks involved, including the potential loss of your pledged asset. By carefully researching your options and preparing thoroughly, you can navigate the process confidently and choose a secured loan that aligns with your financial goals.