What is a Secured Loan? [Everything You Need to Know About it]
Secured loans are generally either business or personal loans that do require a type of collateral (mortgage), which is a predominant mandatory condition for borrowing.
For example, lenders can ask for collateral against a large sum of the loan when the money is used to purchase a significant asset or when the borrower’s credit score is low and not up to the mark. In the case of secured loans, the borrower does get an advantage of enjoying a lower rate of interest, as in this case, the lenders are at a lower risk. However, a few secured loans, such as bad credit personal loans or short-term installment loans, carry a high-interest rate.
If a borrower ends up defaulting on a secured loan that means he or she stops paying the loan amount, then the lender has access to seize the collateral the borrower had mortgaged while borrowing the loan amount. In the case of a secured loan, the lender has access to initiate a foreclosure proceeding.
Secured loans can be found at multiple sources such as banks, online lenders, credit unions, etc.
How do I get a Secured Loan?
As stated above, a secured loan is an easy bet and a safer loan for lenders. Still, the borrowers also get an advantage of paying a lower interest rate than the rate they have to pay in the unsecured load due to lower risk at the lender’s side.
There are multiple options to get a secured loan; for example, you can approach a credit union, online lender, or a bank to get a secured loan. In case when the loan amount is huge, or the borrower has a low credit score, then the borrower will have to mortgage any of his or her collateral. The lender has the collateral possession until the time the entire loan amount is not repaid along with the interest rate.
To get a secured loan quickly, the borrower must maintain a decent CIBIL score as the lenders check the record thoroughly. Also, the borrower needs to have a stable source of income, which gives the lender a guarantee that you will repay the loan timely.
What happens when you default on a Secured Loan?
The nature of a secured loan is such that it gives the lenders a sense of security from the borrower’s side, as the borrower, in most cases of a secured loan, is required to mortgage collateral.
Hence, the collateral is possessed by the lender till the time the total loan amount is not repaid along with interest. If the borrower ends up defaulting the payment, then the lenders have the official access to cease his or her collateral and sell it off at the current market value to regain the losses.
Hence, in the case of a secured loan, the ball is in the lender’s court, which makes it difficult for the borrower to default the loan payment.
Types of Secured Loans
1. Mortgage Loan
A mortgage loan is primarily used to finance a property; it could be either to buy or refinance a home. Mortgage loans are just a way to buying a home without having to put all the cash in the upfront. Generally, in terms of spending on the house, the investment is enormous, and It becomes challenging to pay the entire amount, hence in such a case, a mortgage becomes a necessity.
Also, there are some cases where the investor might have the capacity to pay the entire amount, but a mortgage is still a better option.
For instance, many investors mortgage their properties to free up all their funds to make further investments. However, to qualify for the loan, the borrower is required to meet the eligibility criteria.
For a borrower to get the mortgage loan, here are a few things that should be on point:
A: The borrower must have a stable income, which will guarantee the lender that they will pay the monthly instalments.
B: The borrower should have a decent CIBIL score (which is 580 in case of an FHA loan and 620 for a conventional loan)
C: The debt-to-income ratio of the borrower must mandatorily be less than 50%.
2. Recourse Loan
These are some of the most known secured loans. In terms of the recourse loans, the lender has a higher degree of power as they have lesser limits regarding the assets the lenders can claim against their loan repayment.
If the borrower fails to keep up with his obligation and defaults the agreed payment schedule, then the lender has the authority to go after the borrower and sue his or her assets to claim his share of loss.
From the lender’s point of view, a recourse loan helps reduce the risk associated with the borrower’s less creditworthiness. Since the lenders have access to reduce the risk related to the loan, they have the power to charge a lower interest rate, which gives an attractive option to the borrower.
Example of recourse loan:
The majority of the automobile loans are recourse loans. In this case, if the borrower ends up defaulting, then the lender gets access to claim the ownership of the vehicle and go on to sell it at the current market value. However, the car’s current market value will always be lesser than its amount because a car is a depreciating asset.
3. Car Loans
A car loan is commonly known as an automation or auto loan. A car loan is primarily a sum of money a customer borrows to purchase a car. Car loans are considered the most popular secured loans as they are widely used by the masses and follow the same rules and procedures as any standard loan.
In 90% of the cases, a borrower, while purchasing a loan, will particularly specify to apply for a car loan. However, customers also have an option to use a personal loan as an option for similar purposes. Car loans include many taxes and fees, which get added to the total amount. Many of the individuals apply for car loans at their local bank.
Each loan’s car payment primarily consists of two parts: The principal amount (Which is the amount of loan borrowed) and interest. However, the interest on the car loan does vary and depends on three primary factors, which are:
A: Credit rating of the buyer
B: Whether the borrower is buying a new car or a second-hand one
C: The current market value of the car
As a fact, the interest rates on a new car are generally lower than the rates on the second-hand car.
3. House Loans
A home or a house loan is the simplest form of secured loan. It merely means that borrowers lend a sum of money from the lender (which is generally a financial institution) to purchase a house.
House loans typically consist of either fixed or adjustable rates of interest on their principal amount.
Home loans are standard, and people end up taking home loans either for buying a new house or a plot of land or for renovation, construction, repairs, and extension of the existing house.
The property gets mortgaged to the lender as a part of the security until the full loan amount is not repaid. The financial institution has the authority to hold up the property title till the time loan has been compensated along with the due interest.
The home loan’s interest rate could be either floating or fixed or even partially fixed or floating, whichever suits the conditions of the borrower. There are certain tax benefits that one can avail of on the home loan.
4 Assets that Can be Used as a Collateral for Secured Loan
Here are some of the common assets that could qualify you to borrow a secured loan that needs collateral:
1. Real Estate Property:
A house or a real estate property is considered one of the most common collateral types to get secured loans. Also, a second can be taken at the top against the first mortgage to borrow against the home equity.
The second most common type of collateral used against a secured loan is a vehicle. In case you own any vehicle, for example, a car, boat, etc., you can use it as collateral against a personal loan or an auto equity loan.
3. Personal Investments:
Your stocks or various other investments can also act as collateral against a secured loan. Loans that make use of investments as collateral are known as security-based loans or also stock-based loans. These are the kind of loans often offered by the private banks, investment brokerages to their clients, who have already made investments with their company.
4. Savings-Secured Loan:
A few banks offer saving-secured loans, which are also known as certificate-secured loans. Credit unions or banks offer the kind of loan to the existing customers who have had a decent past. In the case of a saving secured loan, the borrower can keep in deposit their liquid cash, usually in a saving account or a certificate of deposit. At the same time, the customers get a loan for their personal use.
Here are a few points, which clearly state a difference between a secured and an unsecured loan:
- Collateral: The most common difference between the two is the need for collateral to attain a loan. In the case of a secured loan, a borrower will be required to provide collateral to the lender. Whereas, in an unsecured loan, the borrower must not provide an asset as collateral to attain a loan.
- Rate of Interest: Secured loans generally have a lower rate of interest than an unsecured loan. The primary reason is because of the ‘Degree of Risk.’ Unsecured loans carry a higher degree of risk.
- Easy to Obtain: In terms of ease, secured loans are way easy to obtain while it is harder to get unsecured loans as financial institutions find it safe to give out a secured loan.
Recommended: Difference between Secured and Unsecured Loan