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A secured loan puts a borrower’s property, like a car or a home, on the line. Borrowers who don’t repay secured loans could lose this property.
Since they could lose property, borrowers take on more risk when they get a secured loan. But for the lender, this added security makes the loan less risky.
Less risk can help lenders lower interest rates and approve larger loan amounts, increasing buying power for the borrower.
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What makes a loan ‘secured’?
Two key features that are built into secured loans make them work:
- Collateral: The word “collateral” refers to the property that’s tied up in the loan. For a mortgage, the collateral is the home itself. For an auto loan, the car serves as collateral. A savings account balance or certificate of deposit (CD) could also be put up as collateral for a loan.
- Lien: The “lien” is the legal claim the lender has to the collateral. A lien doesn’t mean the lender owns the collateral, just that it has a legal right to take ownership if the borrower defaults on the loan. A lender exercises this right so it can sell the property to pay back some of the money it lost on the defaulted loan.
When the borrower pays off the loan, the lien goes away and the collateral property is once again safe. However, if the buyer stops making payments, the lien allows the lender to start the legal process of taking ownership of the property.
Lenders have less to lose from a secured loan, so they can typically approve bigger loan amounts and lower interest rates compared to unsecured borrowing.
Features of secured loans vs. unsecured loans
Unlike secured loans, unsecured loans rely mostly on the borrower’s promise to repay the loan, not on collateral, for security.
Unsecured loan features
Most credit cards and personal loans use this method. Since lenders have no collateral to build more security, unsecured loans typically have:
- Lower borrowing limits
- Higher interest rates
- Strict approval requirements
If an unsecured borrower loses their job and decides to walk away from a large loan balance, the lender will report the loss to one or more of the three major credit bureaus. This reporting will hinder the borrower’s ability to take out another loan, but it won’t help the lender recoup its current losses.
Secured loan features
Secured loans can help insulate lenders from the effects of an unpaid loan balance. Since lenders can take action to recover their losses, a secured loan can usually offer:
- Higher borrowing limits
- Lower interest rates
- More flexible approval rules
The more valuable and stable the collateral, the more favorable the secured loan terms tend to be. That’s one reason mortgages tend to offer lower rates than, say, used car loans. Home equity historically increases in value while a used car decreases in value. As time passes, the used car will offer less and less security to the lender.
Types of secured loans
Common types of secured loans include:
Mortgages
When you buy a home with a mortgage, the home itself secures the loan. If a borrower defaults on a mortgage loan, the lender can foreclose on the home and sell it to someone else.
Home equity loans
A home equity loan, also known as a second mortgage, uses a home you already own as collateral. Lots of homeowners use home equity loans to pay for renovations. Like a primary mortgage lender, a home equity lender also puts a lien on the home.
HELOC
A home equity line of credit, or HELOC, opens a credit line that’s secured by the value of your home. You could think of a HELOC as a secured credit card, with the security from the home pushing down interest rates. HELOC lenders put liens on homes for security.
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Auto loan
With an auto loan, the car you’re buying serves as collateral. The lender could repossess the car if you stopped making loan payments. Cars can depreciate in value quickly, so loan terms are typically shorter than mortgage loan terms, typically five to seven years instead of 30 years.
Secured vs. unsecured: The central trade-off
Here’s how secured and unsecured loans, generally, compare:
| Feature | Secured loans | Unsecured loans |
|---|---|---|
| Interest rates & fees | Lower | Higher |
| Loan amounts | Higher | Lower |
| Approval requirements | More flexible | More strict |
| Risk to borrower | Higher (could lose asset) | Lower (no collateral) |
Compared to unsecured loans, secured loans exchange borrower risk for more borrowing power. That’s the central trade-off.
Knowing the secured borrowing risks
Trading risk for borrowing power. Is this exchange right for you? To answer that question, it’s important to know the risks you’re taking.
1. Foreclosure and repossession
If you miss several loan payments on a secured home loan and can’t catch up, foreclosure is a real possibility. During foreclosure proceedings, the homeowner has to leave the home. The lender takes ownership and sells the home to pay off the loan balance.
Primary mortgages, home equity loans, and HELOCs come with a risk of foreclosure. Secured auto loans risk repossession of the automobile.
How to manage this risk: Use secured loans to borrow only what you need and can afford to repay. Using a home equity loan to renovate your home is probably worth the risk; using a home equity loan to pay for a vacation probably isn’t.
2. Longer terms can cost more over time
Secured loans offer longer repayment periods, and stretching debt across a longer payoff term lowers monthly payments. But longer terms can also add to the interest paid over the life of the loan.
For example, a 30-year mortgage of $300,000 at 6 percent charges $347,515 in interest, assuming the borrower makes all payments on time. Shortening the same loan to 15 years charges only $155,683 in interest, a savings of $191,832.
Similarly, a $35,000 new car loan at 7 percent over seven years adds $9,372 in interest when paid on schedule. The same loan over five years charges $6,583 in interest, a savings of $2,789.
How to manage this risk: Even if you get a long loan term, try to pay extra on the loan’s principal each month. Paying down principal shortens the loan term and saves interest.
3. Negative equity is possible
Some people call it “being under water” on a loan. Others call it “negative equity.” By any name, it means the value of the loan’s collateral is lower than the loan’s balance.
Here’s an example: Let’s say you bought a $350,000 home last month. You used an FHA loan, putting down the 3.5 percent minimum, and you rolled the FHA’s 1.75 percent upfront mortgage insurance premium into the loan balance. This means you borrowed $343,875.
After you closed on your loan, property values in your neighborhood fell and your home is now worth $330,000 instead of $350,000. If you sold the home today for $330,000, you’d need to bring $13,875 more to closing to pay off the loan balance.
Fortunately, in the long run, real estate tends to increase in value; home values that decline tend to bounce back a few years later, assuming the home is maintained. Plus, making regular mortgage payments will slowly lower the loan balance. So the problem in this example could solve itself if the homeowner stays in the home several more years.
But what if you had to sell this month because of a new job in a different state? You could lose money on the transaction.
Negative equity can be a bigger problem with car loans since cars lose value as time passes.
How to manage this risk: Try to negotiate a lower purchase price for the home or car. Make a bigger down payment, if possible. Avoid financing fees into the loan amount, if possible. Pay extra on the loan’s principal: Lowering principal can tame loan-to-value ratios, LTV, and keep a loan above water even if property values fall.
Is a secured loan right for you?
A secured loan can unlock enough borrowing power to buy an expensive asset like a home or new car. Like any tool, a secured loan works best when used correctly.
| When a secured loan makes sense | When to consider an unsecured loan |
|---|
| You’re buying or renovating a primary residence | You’re buying consumer goods |
| You’re investing in a long-term asset like education | You’re meeting a short-term need like a vacation |
| You need to borrow a large amount of money | You could afford the expense without borrowing |
| You earn enough to make the payment without stress | You’re not sure you can afford the monthly payment |
| You need the car to get back and forth to work | You’ll use the car mostly for recreation |
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FAQs about secured loans
What’s the difference between a secured loan and a personal loan — and which should I get if I need $30,000?
A secured loan requires collateral; a personal loan does not. A $30,000 secured home equity loan will likely charge less interest and lower payments than a $30,000 personal loan, but the home equity loan also puts your home on the line while a personal loan does not.
If I use my home as collateral and lose my job, can the bank actually take my house?
Yes. If you stop making payments – and you don’t catch up or work out an alternate payment plan with your loan servicer – the lender can initiate foreclosure proceedings. Typical lenders don’t want to foreclose and will try all other options first, but foreclosure will happen if all else fails.
I have a credit score around 620 — can I still qualify for a secured loan using my home equity?
Maybe. Many lenders will allow credit scores as low as 620, as long as the borrower has enough income to make the loan’s payment while still paying other debts and as long as the home has enough value to secure the loan amount. Borrowers with credit scores of 720 or higher may qualify for lower interest rates than borrowers with a FICO of 620.
Is a home equity loan considered a secured loan? How is it different from a regular mortgage?
Yes, a home equity loan is a secured loan. The security comes from the value built up in your existing home. A regular mortgage finances a new home, using the new home itself as collateral.
I don’t own a home — what kind of secured loan can I get?
You could use a savings account balance to secure a loan. For example, some people who need to build credit use secured credit cards to establish a solid payment history without paying exorbitant interest rates. A first-time home buyer mortgage is available to people who want to buy a home and start building equity which can later be used as collateral for a loan.
What happens to a secured loan if I sell the house before it’s paid off?
This happens a lot. The secured loan must be paid off at closing. For instance, if you owed $50,000 on a home equity loan and sold the home for $300,000, you’d use $50,000 of the $300,000 to pay off the home equity lender. The remaining $250,000, minus selling fees, would be yours to keep, assuming no other liens were assigned to the home.
Is a HELOC safer than a home equity loan? I’m nervous about using my house as collateral for either.
HELOCs and home equity loans carry the same fundamental risk: Your home is the collateral. A HELOC offers more flexibility. It can be paid off, re-used, and paid off again repeatedly during its draw period, which usually lasts 10 years. During this time most HELOCs charge a variable interest rate. A home equity loan creates predictability with its fixed payments and fixed interest rate.
Is a cash-out refinance a secured loan?
Yes, a cash-out refinance uses home value to secure a lower mortgage rate and larger loan amount. A cash-out refi combines a primary mortgage with a home equity loan, rolling both loans into a single payment with a single interest rate. Cash-out refinancing is a good way to get a lower rate on the primary mortgage while also borrowing money for renovations.
I have about $80,000 in equity. How much could I actually borrow?
Most lenders allow you to borrow up to 80 to 85 percent of your home’s value, minus what you still owe on your mortgage. Based on this rule, if your home is worth $400,000, you could carry $320,000 to $340,000 in total mortgage debt on the home. Lenders may call this percentage your CLTV, or combined loan-to-value ratio. If your primary mortgage balance already meets or surpasses your CLTV limit, you have no available equity to borrow.
Balancing the risk vs reward
Tying property to a loan expands borrowing power, allowing people to buy homes and new cars they otherwise couldn’t afford.
Most of the time, this works well. Buyers leverage the power of secured borrowing without losing their collateral. But that’s not a guaranteed outcome; collateral really is at risk.
Secured loan borrowers should make sure they’re using this tool the right way. For many people, using a secured mortgage to buy or renovate a home is an acceptable risk vs. reward tradeoff.
...in as little as 3 minutes – no credit impact