What Is a Secured Loan and How Does It Work?

A secured loan is a type of debt backed by collateral, which is something you own, such as a house, car or savings account. There are different types of secured loans, but they all have one thing in common: If you fail to repay the loan, you can lose your asset.

What to know about secured loans

Banks, credit unions and online lenders offer secured loans. Eligibility is typically based on the value of your collateral as well as your credit and finances. You’ll often undergo a hard credit check when you apply for a secured loan.

Most secured loans have fixed interest rates, meaning you'll repay the loan in equal monthly installments. If the lender reports payments to the three major credit bureaus, on-time payments will build your credit, but missed payments will damage it. After multiple missed payments, the lender can take your collateral.

Secured loan amounts vary and are often determined by the value of the collateral. For example, a secured home loan, or mortgage, typically covers the value of the house minus your down payment. The same goes for an auto loan. A pawn lender puts a price on your property and loans a percentage of that amount.

Secured loans tend to have lower rates and longer repayment terms than their unsecured counterparts because the lender has something to take if you can’t repay the funds. Even a pawn loan, which is a secured no-credit-check loan, may have a lower APR than an unsecured payday loan.

Pros and cons of secured loans

Types of secured loans

Here are several types of secured loans and the collateral that’s usually used to secure them.

Secured vs. unsecured loans

The key difference between secured and unsecured loans is collateral. If you fail to repay the loan and the lender can take an asset of yours, it’s a secured loan.

If not, the loan is unsecured, which means the lender will review only your financial and credit information such as your credit history, income and other outstanding debts to determine whether you qualify and at what rate.

When to get a secured loan

• You can get a lower rate. Since secured loans typically have lower rates than unsecured loans, a lower interest rate may be reason enough to get one.

• You can accept the risk of losing the collateral. Even if you have a plan to repay the loan, ask yourself if the lower rate is worth the potential to lose your property or other assets.

When to get an unsecured loan

• You need funds fast. It can take as little as a day or two to apply, get approved and receive funds from an unsecured personal loan. Because a secured loan requires the lender to assess your collateral, it can take longer to receive the funds.

• You don’t want to risk losing collateral. Because unsecured loans don’t require collateral, the lender can’t seize your home, vehicle or savings account to recover funds if you don’t make payments.

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How to get a secured loan

1. Check your finances. Review your budget before getting any loan to understand how much you can put toward monthly repayments. Use a loan calculator to see how the interest rate and repayment terms affect the monthly payment. Check your credit reports for any errors or past-due accounts you can resolve before applying. You can get your reports for free at AnnualCreditReport.com or on NerdWallet.

2. Review the collateral. If you're using collateral to lower your rate or get a larger loan, check its value before you apply. You can use an online pricing guide to check a car's value for an auto-secured loan, review your savings and investment accounts for an account-secured loan or take a personal item to multiple pawn shops to see which gives the highest valuation.

3. Compare lenders. Look for a secured loan with a low rate and affordable monthly payments. Lenders may weigh collateral, credit and income differently, so it pays to compare. If your bank or credit union offers secured loans, start there to see if they'll include customer perks or discounts.

4. Apply. The application process is different for all types of secured loans. You may be able to get a secured loan online, while some banks and credit unions require an in-person visit. Applications for a secured loan may take longer than an unsecured loan because the lender must evaluate your collateral.

What happens if you default on a secured loan?

If you miss a secured loan payment on a secured loan, the lender may not repossess your asset right away. Your loan contract should include when action can be taken after a late or missed payment.

Here are the potential consequences for defaulting on a secured loan.

1. Late fee: When you miss a payment due date, the lender may charge a late fee. There’s usually a grace period of about 15 days when you can make the payment to avoid the fee.

2. Negative credit reporting: If the lender reports to the credit bureaus (like on a mortgage, auto or personal loan) a payment more than 30 days late will show up on your credit reports and could have a significant negative impact on your scores.

3. Repossession or foreclosure: If you go long enough without paying your secured loan, a lender can take the asset used to secure the loan. A repossession or foreclosure will likely go on your credit report and stay there for up to seven years, making it difficult to access credit in the future. If the asset — a car or house, for example — doesn’t sell for enough to cover the outstanding loan amount, you may still owe the lender money.

What to do if you can’t repay a secured loan

Communicate with your lender

There are no consequences to your credit or finances for telling your lender you're concerned about missing a payment as long as you call before you miss it. The lender may even be able to help: Some companies have hardship programs that include payment deferrals or lower monthly payments.

Request a new payment date

If you've got a new job or added bills that make the loan's payment date challenging to honor, request a different payment date. You may also be able to change the payment frequency.

Seek credit counseling

A nonprofit credit counseling agency can provide budgeting help, debt management plans and housing counseling. Some assistance may be free.

Ask for help

If a trusted friend or family member can provide financial assistance, ask for it. Though it may be a difficult request, it could keep you from losing your property or savings.