Some types of loans, such as mortgages, are always secured loans. But with other types of debt, you may have the option of choosing between secured and unsecured options.
What type of loan is the best? In short, it really depends on your specific situation. In some cases, a secured loan might be a good choice, but it could also put you at higher risk. Here’s what you need to know.
What is a secured loan?
A secured loan is a type of loan secured by collateral that you own. If a borrower defaults on a secured loan, the lender can seize the collateral to minimize his losses. Here are some common examples of secured loans:
- Mortgages : Secured by your home or property
- Auto loans : Secured by your vehicle
- Secured credit cards : Usually guaranteed by a deposit
- Guaranteed personal loans : Could be secured by a variety of financial assets
These are just a few examples of secured loans. But anytime you finance the purchase of a physical item, be it a sofa or a boat, there’s a good chance you have a secured loan. In either case, the lender has the right to repossess the collateral (if you miss a payment) until the loan is fully repaid.
What can be used as collateral for a secured personal loan?
With auto loans or mortgages, the item you buy is also the collateral. But with personal loans, you get cash instead of a physical asset. For this reason, most personal loans are unsecured.
However, there are ways for a borrower to get a personal loan. Here are some assets that a lender can accept as security for a personal loan:
- Home equity
- CD savings account
- Vehicle Title
- Insurance conditions
- Stocks, bonds and other stocks
- Precious metals
What are the advantages and disadvantages of a secured loan?
Secured loans are less risky for the lender. For this reason, they may be willing to offer you better terms for a secured loan than an unsecured loan.
Choosing a secured loan could allow you to get a lower interest rate, a higher borrowing limit, or better repayment terms. And if you have a limited or damaged credit history, pledging an asset as collateral could help you get loan approval.
But while secured loans may offer more borrowing options or more attractive terms, they also represent a higher risk for you as a borrower. If you don’t repay the loan, the bank can take back your house, car, jewelry, or whatever was used as collateral.
It is also important to point out that not all secured personal loans offer better terms or rates than their unsecured counterparts. In fact, secured loans for borrowers with bad credit (like title loans or pawn shops) often charge high fees and high interest rates.
Should You Pay Off Your Unsecured Debt With A Secured Loan?
If you are facing overwhelming credit card debt, you might be tempted to take out a second mortgage or title loan on your paid off vehicle to consolidate your debt at a lower interest rate.
At first glance, this may seem like a good financial decision. But, in reality, this is a very dangerous decision because you would be moving a form of unsecured debt to secured debt.
While dealing with credit card collection agencies can be overwhelming, they cannot confiscate your personal property without getting a court judgment. But once you switch to a secured loan, your collateral is now at risk.
Is taking out a secured loan a good idea?
In some cases, taking out a secured loan can be a smart move. For example, your bank may offer you a better interest rate and better terms on a home equity loan than an unsecured loan. Plus, a secured loan could help you rebuild a damaged credit rating.
On the other hand, some secured loans for borrowers with low credit scores, such as vehicle title loans, can charge exorbitant rates and fees. Before taking out a title loan, make sure you have explored all of your other borrowing options, such as alternative payday loans (ALP), which are offered by credit unions.
As with any loan, you need to make sure that you can really pay your monthly payments on a secured loan. And be sure to do your research and compare lenders before choosing the secured loan that’s right for you.