What is a secured loan and how does it work?

What is a secured loan and how does it work?

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A secured loan is a loan that is backed by collateral. Because you must use one of your assets to secure the loan, secured loans are easier to qualify for than unsecured loans. They can be an effective way to get the funds you need, but they do come with risks.

Secured loans are loans that are protected by collateral. This means that when you apply for a secured loan, the lender will want to know which of your assets you plan to use to back the loan. The lender will then place a lien on that asset until the loan is repaid in full. If you default on the loan, the lender can claim the collateral and sell it to recoup the loss.

It is important to know precisely what you are promising and what you stand to lose before you take out a secured loan.

Secured loan vs. unsecured loan

Some loans, such as personal loans, can be either unsecured or secured, depending on the lender. If you don’t qualify for the unsecured option or you’re looking for the lowest possible interest rate, check to see if the lender offers a secured option for the loan you’re interested in.

When it comes to choosing a secured versus an unsecured loan, there are multiple factors to consider. Here are as few of the differences between the two and some benefits and downsides of each loan type:

Types of secured loans

Lenders want to know that they have leverage once you walk away with their money. When they place a lien on your collateral, they know that in a worst-case scenario, they can take possession of the assets you’re using as collateral. This does not guarantee that you will repay your loan, but it does give lenders a greater sense of security and gives the borrower more impetus to repay the loan.

  • Mortgage: With a mortgage, you put your home or property up as collateral to buy that home. If you fail to make the payments, your home can be foreclosed on.
  • Home equity line of credit: A home equity line of credit (HELOC) gives you access to your home equity in the form of a credit line, like a credit card. With a HELOC, you also put your home up as collateral.
  • Auto loans: When taking out a loan to pay for a car or any other vehicle, your vehicle will be used as collateral. If you don’t make the payments on time and in full, your vehicle could be seized.
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