What is a Secured Loan and How Do They Work?
When you take out a secured loan, you put forward the equity in your property, or other assets, as security. This means secured loans come with extra risk as, if you fail to repay them, the lender could repossess this property.
Secured loans are one option if you want to borrow money. They are backed by a high-value asset, typically your home, which can help to improve your chances of getting accepted for a loan.
However, while a secured loan is generally considered less risky for lenders, the risk is greater for the borrower as they could lose their property if they don’t repay it in full.
Read on to find out more about the different types of secured loans, how they work, and when you might choose to take out a secured loan.
What is a secured loan?
A secured loan is a type of borrowing that uses an asset as security. This is known as ‘collateral’ and it minimises the risk for the lender if you don’t manage to repay the loan.
Many secured loans will be secured against your home, but they can also be secured against other assets, such as vehicles, jewellery and other high-value items.
If you don’t make your loan repayments, the lender could repossess the asset you put forward as security so they can recover the funds they are owed.
This is in contrast to unsecured loans, which are not secured against any kind of asset.
Since the collateral gives lenders extra reassurance by mitigating some of the risk of lending, you can typically borrow more with a secured loan than an unsecured loan and potentially access lower interest rates.
» MORE: What is an unsecured loan?
Types of secured loan
There are several types of secured loans. The most common form of secured lending is against property, but loans can also be secured against cars and other valuable assets.
Examples of secured loans include:
- Mortgages. These are perhaps the most well-known type of secured loan, with the debt secured against your home until you finish making repayments.
- Second charge mortgages. Also called homeowner loans, these loans are secured on the equity you own in your home. If you have an existing mortgage, a new loan that’s secured on the same property is called a “second charge mortgage”. Find out more on how second charge mortgages work.
- Bridging loans. These are a kind of short-term loan that can be used to help bridge the gap between buying a new property and selling an existing one, for example. They are secured against the value of a property, and are most commonly used against commercial property.
- Car finance. All car finance agreements are secured against your vehicle. The finance provider legally owns the vehicle while you make repayments so, if you default on the loan, they could repossess your vehicle.
- Logbook loans. This is an expensive form of borrowing that allows you to access a loan secured against a vehicle you own. You can continue using the car but, until you repay the loan in full, ownership of the vehicle passes to the lender.
- Pawn shop loans. If you go to a pawnbroker, you can receive a loan based on the value of an item, such as jewellery, which the pawnbroker will keep while you repay the money. This is a kind of secured loan as the item you pawn is used as collateral.
How does a secured loan work?
In many ways, secured loans work like any other loans. When you apply for funding, lenders will perform a credit check and assess your overall financial situation to see if you would be able to repay it.
The value of your property and the amount of equity in your house you actually own will help to determine how much you can borrow with a secured loan, alongside the standard affordability tests.
Secured loans are often for larger sums of money and are secured on property, so the application process may take longer than for an unsecured loan.
Most secured loans are taken out via a broker, although it is possible to get secured loans directly from a lender.
If approved for the loan, you will then need to make the agreed monthly repayments. If you pay on time, this will feel like repaying any other type of loan.
However, if you miss a payment, you risk losing the asset you put forward as security. If you continually miss repayments, the lender could repossess the asset so it can get back the money it is owed. This wouldn’t happen with unsecured loans as they are not backed by any kind of security.
» MORE: What is a homeowner loan?
Pros and cons of a secured loan
As secured loans are such a big financial commitment, it is important to know their potential benefits and drawbacks.
What documents do I need for a secured loan?
When applying for secured lending you may need to provide the lender with:
- proof of identity, such as your driving licence or passport
- proof of address, such as a utility bill
- proof of employment and income
- bank statements
- details of the asset being used as security
The lender will also conduct a credit check, to see how you have managed credit and repayments in the past.
» MORE: Loan application tips
Why might you choose a secured loan?
There are many reasons why you might choose to take out a secured loan, but you should be certain that it’s the right decision before applying.
You may want to consider a secured loan if:
You want to borrow a larger sum of money
You will typically be able to borrow more with a secured loan than an unsecured loan, so it is useful if you need a substantial amount of money – to pay for home improvements, for example.
However, a secured loan is not the only option. You could consider applying to borrow more on your existing mortgage, or even look into remortgaging to see if that offers a better opportunity for you.
If you want to borrow a smaller amount of money, then an unsecured loan may be more suitable and it won’t put your property at risk.
You don’t have a good credit score
Secured loans may help those with poorer credit scores to access finance with relatively lower interest rates. Secured lenders have the added security of your property, in case you can’t repay the loan, so their interest rates will often be lower than on an unsecured loan.
If you have a less-than-perfect credit score and need to apply for finance, you could also consider using a guarantor to support your application. The guarantor agrees to repay the loan if you miss payments, which reduces the risk for the lender.
» MORE: How to improve your credit score
You want to consolidate your debts
Individuals with a number of existing debts may choose to consolidate them with a secured debt consolidation loan. While this can help to make your debts more manageable and can reduce your monthly repayments, you should always check to see how much you will be repaying overall. If you repay your debts over a longer period of time, you may end up paying more interest and paying more overall.
Furthermore, you should bear in mind that by consolidating unsecured debt with a secured loan, you will be putting your property at risk if you don’t manage to keep up with repayments.
What to consider before getting a secured loan
A secured loan is a significant commitment, so you should only apply if you are confident that you will be able to repay it in full. You need to be sure that the benefits of taking out a secured loan outweigh the risks of using your property as collateral.
If you can get an unsecured loan that meets your requirements, then this could be a more suitable option as it won’t put your property directly at risk. Check your eligibility for an unsecured loan.
To help you find the most suitable loan, you should work out how much you need to borrow and how long you want to repay it. You can then compare the total cost of borrowing by looking at a loan’s annual percentage rate (APR), which includes interest charges and any additional fees.
If you decide that a secured loan is right for you, use our website to compare lenders and see what deals you could be eligible for.
» COMPARE: Secured loans
WARNING: Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a loan or any other debt secured on it.
Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more