What Is a Secured Loan and How Does It Work?
A secured loan is a type of debt that requires collateral.
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Head of Content, Personal & Student Loans What is a secured loan?
A secured loan is a type of debt backed by collateral, which is something you own, such as a house, car or savings account. Banks, credit unions and online lenders offer secured loans.
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.
How does a secured loan work?
Qualifying for a secured loan 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.
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 rates and terms
Most secured loans have fixed interest rates, meaning you'll repay the loan in equal monthly installments. Secured loans tend to have lower annual percentage rates, higher loan amounts 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.
Secured loan amounts
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.
Pros and cons of secured loans
Pros
- May be easier to get than an unsecured loan. Secured loans often have softer credit and income requirements than unsecured loans because the collateral is a factor on your application.
- Lower rates, higher loan amounts. Secured loans may have lower rates and higher loan amounts than unsecured loans, depending on the loan type and lender.
- On-time payments build credit. Like other types of credit, most secured loan payments are reported to the three major credit bureaus, so on-time payments can help build credit. However, missed payments can hurt your score, in addition to putting your collateral at risk.
Cons
- Risk of losing collateral. You can lose your collateral if you don’t repay a secured loan, which could be a life-changing setback if the collateral is something like a 401(k), vehicle or your home.
- May take longer to receive funds. Some types of secured loans take longer to fund than unsecured loans. For example, an unsecured personal loan may be approved and funded in a day or two, but a secured personal loan may take longer because a lender must assess the value of your collateral before approval.
Types of secured loans
Here are several types of secured loans and the collateral that’s usually used to secure them.
| Secured loan type | Collateral |
|---|---|
| Your 401(k). | |
| The vehicle you’re purchasing. | |
| Your vehicle. | |
| Your certificate of deposit. | |
| Your crypto. | |
| Your home. | |
| The home or property you’re purchasing. | |
| A personal item. | |
| Typically a vehicle, savings or investment account. |
When to get a secured loan
You might want to consider a secured loan if:
- You have a low credit score. If you have bad credit (a score below 630) or fair credit (a score from 630 to 689), it may be easier to qualify for a secured loan than an unsecured 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, you face the potential of losing your property or other assets if your financial situation changes and you miss payments.
When to get an unsecured loan
Alternatively, an unsecured loan may be a better option if:
- 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.
🤓 Nerdy Tip
Comparing secured and unsecured loans is mostly about weighing the difference in affordability against the risk of losing your collateral. One way to determine whether it’s worth getting a secured loan is to first pre-qualify for an unsecured loan. Taking the steps to pre-qualify typically won’t affect your credit and can show you the loan amount, APR and repayment term you could get. » GET STARTED: Pre-qualify for a personal loan on NerdWallet
How to get a secured loan
- 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.
- 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.
- 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.
- 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 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.
- 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.
- 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.
- 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 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 to have smaller biweekly payments rather than a larger monthly payment. Keep in mind that making biweekly payments may mean you’ll pay more per year than if you make monthly payments.
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 a family loan may be a difficult request, it could keep you from losing your property or savings.
Frequently Asked Questions
Is a payday loan secured or unsecured?
Payday loans are unsecured because you don’t need to provide collateral to get one. Instead, a payday lender may ask for access to your bank account and withdraw the loan amount, plus a fee, on your next payday.
Is a small business loan secured or unsecured?
Small business loans can be secured or unsecured. Lenders typically accept property or equipment as collateral. A lender may require a UCC lien, which allows the lender to claim your business assets if you default.
Is a personal loan secured or unsecured?
Most personal loans are unsecured, but some lenders offer secured personal loans. Lenders typically accept a vehicle, savings or investment account as collateral on a secured loan.
» MORE: Compare personal loans
Are student loans secured or unsecured?
Private and federal student loans are unsecured, meaning you can’t add collateral to the application. Student loan borrowers who need help qualifying may add a co-signer with a strong credit profile.
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