What is a Secured Loan? How Collateral Can Help You Secure Financing

Nothing warms up a lender’s heart like good ol’ collateral! Dangle some valued property in front of them, and you’ll likely see that loan approval much quicker.

Now, just what would a secured loan be, you may ask? It’s actually quite simple. With a secured loan, you’re putting up something valuable as a guarantee that you’ll pay back what you borrowed.

A secured loan is a type of loan where you pledge an asset, such as your home or car, as collateral to guarantee repayment to the lender.

If you don’t, then the lenders will grab that collateral in a heartbeat.

I’m going to walk you through the ins and outs of secured loans, show you how collateral plays a key role, and give you the tools you need to decide whether this type of financing is right for your needs.

If you want to get a feel for how secured loans work, then read on. Knowing what makes these loans tick will keep you on a lender’s good side and might just save you a pretty penny down the road.

Collateral Requirements

When you’re dealing with secured loans, collateral is the secret sauce that makes everything happen. Lenders want something they can cash in if you fail to pay them back what you owe. Be it an automobile, a house, or anything of value, this just sweetens the deal for creditors.

Collateral lowers their risk since, if things happen to go sour and you cannot repay, they have something of value to sell, often at auction. Collateral can be good for you, the borrower, too.

Collateral lowers prices and improves access for secured loans by putting most of the risk on the borrower.

Since this makes the lender more secure, they may lend you more money at better interest rates.

Plus, you’re almost bound to get approved — even when your credit isn’t perfect. However, offering up collateral means the risk is on you. If you don’t pay your installments, you’ll lose your collateral.

Once, loans required nothing more than a handshake. Now, there’s plenty of paperwork involved.

The lender trusts you with their money because they know they have something of value to fall back on. It’s a win-win for everyone as long as you hold up your end of the bargain.

Secured Loans vs. Unsecured Loans

Because collateral lowers the lender’s risk, secured loans generally have lower interest rates. In contrast, unsecured loans depend purely on your credit history and have higher interest rates because, quite frankly, there isn’t any collateral to back them up.

What this really means is that at the end of the day, secured loans let the lender sleep easy at night, while unsecured loans rely more on your creditworthiness.

Secured Loans Have Many Uses

Secured loans are available in a cluster of shapes and sizes. One of the most common is the mortgage. It uses your home as collateral, which is another way of saying that if you stop paying, the lender has the right to seize the old homestead. 

Auto loans work similarly: The vehicle that you are purchasing is collateral. If you don’t pay up, the repo agent will be knocking on your door. Actually, the agent will more likely take your car when you aren’t looking — who needs confrontation?

Borrowers use collateral to obtain mortgages, auto loans, and personal loans they would not otherwise qualify for.

Then you have personal secured loans where you can put up something like your savings account or investments for collateral. These are mighty handy when you require some cash for life’s expenses and you would rather not be selling off your prized assets just yet.

Whatever the type, all these loans are based on one simple principle: in case you fail to uphold your side of the bargain, the lender has their eyes set on your collateral and is ready to grab it!

Mortgages, auto loans, and secured personal loans are among the most popular types of secured loans. Each has a bit different way of locking up collateral for what you owe, so it pays to understand their innards.

Mortgages

A mortgage is about as big as loans get, and it’s tied right to your house.

When you take out a mortgage, the lender holds a lien on your home against that loan, meaning if you stop paying, it can take the property. That’s why the lender feels safer lending you all that money — it has something really valuable as a backup.

Mortgages involve big money and long periods — usually 15 or 30 years. Over this time, you’ll be paying the loan back plus all the accumulated interest. It’s a serious commitment, kind of like getting married, only this time it’s to your house. You better keep up those payments, or you’ll be in more hot water than a lobster at a low country boil.

Of course, the good news is that once you pay the loan off, the home is yours, free and clear. But until every last dime is paid, the lender has got its claws sunk deep into your property.

Auto Loans

Auto loans work similarly to mortgages, except you’re putting your car or truck up as collateral instead of your house.

You are borrowing the money to buy the vehicle, and if you happen to miss a few payments, well, the lender can repossess it quicker than an ice cream brain freeze.

Most car loans last from three to seven years, depending on how fancy a ride you’re getting. Just as when buying a house with a mortgage, you’re paying for interest in addition to the principal.

The lender keeps a lien on the vehicle until you pay it off. It’s like having a sniper keep a scope on you for years at a time.

There are some differences: a car isn’t worth as much as a house, and it’s going to lose value faster. That means if you fall behind on the payments, you may end up owing more than the car’s worth, and that’s a hole you would rather not dig yourself into. Even after the repo agent takes your vehicle, you may still owe the lender for any shortfall once it auctions off the car.

Secured Personal Loans 

Now, with a secured personal loan, you’re literally putting something of value on the line as collateral.

It won’t be on your house or truck, but you could potentially be putting at risk your hard-earned savings, investments, or even that solid gold statue of Zeus that Aunt Bessie gave you. 

The lender will be sleeping easy knowing it’s got a valuable item it can snatch if you stop paying. That may be why it was willing to lend you money in the first place.

These loans come in real handy when you need a big fat pot of money, like for fixing up the house, paying an avalanche of medical bills, or any other situation that’s costly. Since the lender will have hold of something dear to you, it may give you a break with lower interest rates and better terms. 

I suggest you be darn sure you can pay off that loan, lest you watch your pride and joy disappear like smoke on a windy day.

Well, before you go scrounging up a secured loan, you’d better know both sides of the coin — good and bad. While these loans can give you a leg up, they can easily knock you flat if you aren’t careful.

Benefits

A secured loan can put more money in your pocket at a lower cost, with less likelihood of disappointment:

• Potential Lower Interest Rates: A major plus side is that the lender will most probably offer an interest rate lower than that of an unsecured loan. That’s because it has an iron grip on something you own, so it’s not working up a sweat over getting its money back.
• Larger Loan Amounts: When you put something up for collateral, like your house or your ride, you can often get a bigger loan. The lender knows it’s got more to hold over your head, so it’s less afraid to hand out a bit more green.
• Easier Approval: If your credit is looking shaky, then it takes collateral to get you past the lender’s door. The lender may be mighty confident in this case since it has your valuables on the line and is more likely to give you a thumbs-up for the loan.

Drawbacks

Just remember that a secured loan puts your money on the line for a longer time than you may want:

• Risk of Losing Collateral: Here’s the kicker: If you fumble those payments, you can lose whatever collateral you put up. The lender will take it — your house, car, or whatever’s on the hook — without so much as a “sorry!”
• Longer Repayment Terms: Secured loans can stretch out over more years than a person wants to count, so you may be chained to those payments for a long haul. And trust me, paying off a loan can start feeling like carrying a monkey on your back after a while.
• Potentially Complex Application Process: Getting everything lined up with a secured loan can take more paperwork than you might imagine. With all the hoops to jump through, this process can get more tangled than a sheep in barbed wire. 

Secured loans can be your trusty horse or a bucking bronco. Saddle up smart, and you just might ride off into the sunset with a pocket full of cash, but lose your grip, and you could end up flat on your back!

Getting a secured loan is not one of those things you jump into, especially without knowing what’s going on. Understanding how it works will save you from all kinds of headaches that may come your way.

Prepare Your Collateral 

First things first: You must figure out what property you’ll be putting on the line. Be it your house, car, or a pile of stocks, you need to know what it’s worth. Take a good, long look at your assets and make sure they’re in good shape — a lender won’t take kindly to something that’s falling apart.

The best scenario for lenders is well-maintained collateral with thorough documentation.

You probably want to get an appraisal or, at the very least, do some research so that you have an idea of the value and are thereby not shortchanged.

If you’re pledging a car, make sure it is shiny and the motor is running smoothly. Whatever collateral you’re posting, the papers should be in order. The lender will want to verify that you are the legitimate owner, so do your homework first.

Present the Needed Documentation

Now, to get that loan, you’ll have to present some paperwork to the lender. It wants to make sure everything is on the up and up before it forks over the cash.

Here is what you will likely need to collect:

• Proof of ownership of the collateral (a clear title, deed, bill of sale, and account statements)
• Verification of income (pay stubs or tax returns)
• Credit report and score
• Appraisal or valuation of the collateral
• Identification (driver’s license or other photo ID)

With all that in your hands, you’re halfway there. The more organized the papers are, the smoother the process will go.

Go Through the Lender Evaluation Process 

Now, the fun part where the lender examines your property. It will take a close look at your collateral to make sure what it’s really worth. If it’s a car, the lender wants to know how many miles are on it, how old it is, and whether it’s in decent condition. For property, a clear title and market value will be verified to see if it all adds up.

Apart from collateral, the lender will check into your financial background. It needs to verify that you are capable of paying back your loan, so it looks into your credit history, your income, and other loans you’ve taken. 

The stronger your credit, the easier everything will go. After the lender has checked all that, it’ll make a decision. If everything is OK and you have your ducks in a row, then you’ll get the loan. But if something’s out of whack, the lender may turn you down or ask for more collateral. Just be ready for a little back-and-forth because this process can take some time.

Secured loans only make sense if you are positive that you can repay the money you borrowed or if you don’t mind losing your collateral (though that’s difficult to imagine). Pledging your property as collateral is the magic key that opens up the lender’s treasury. 

Repay the loan responsibly, and your credit score may increase, making your next loan that much easier to get.