When confronted with a large and unexpected expense, you may find yourself considering taking out an unsecured or secured personal loan to help tide you over. While both may be convenient options, taking out a secured loan may be a better fit for some borrowers. To know if secured borrowing is right for you, it’s important to understand what secured loans are and how they work.
What is a secured loan?
Secured loans are a way to borrow money by backing the loan with a form of collateral. Collateral can be a vehicle you own, your home or, in some cases, certain valuables like jewelry — the specifics are determined by the lender. Providing collateral reduces the risk the lender assumes and may make it easier to qualify for the loan.
A secured loan can be a path to building credit, qualifying for a lower interest rate or being approved for a larger loan amount, but it’s important to understand your obligations first.
What to consider when getting a secured loan
Although applying for a secured loan is a way to get extra cash, there are a few things to consider before moving forward. First and foremost is being aware of the risks if you default on a secured loan. If you fail to make your loan payments, the lender has the right to seize your collateral and sell it to recoup the payments they are due.
Here are some other things to consider.
You need to own your collateral
If you’re considering borrowing by using your car as collateral, you need to own the vehicle. You may not qualify for a loan secured with a vehicle if you have not fully repaid your car loan or if the car does not meet the lender’s eligibility and value requirements. The resale value of the vehicle will also determine the loan amount you’re eligible for. Your lender will typically appraise your collateral to decide how much they can lend you.
You may benefit from a lower interest rate
One of the main benefits of a secured personal loan is that it may allow the borrower to get the funds they need at a comparatively lower interest rate. Since the presence of collateral reduces the lender’s risk, they may allow for a higher borrowing limit. In addition, the lender considers the applicant’s credit history, debt-to-income ratio, income and other factors when determining the loan terms.
However, a borrower who cannot repay their loan faces the real risk of losing the collateral. This could mean losing the car that they relied upon — or even their home, if the loan is a mortgage, home equity loan or home equity line of credit.
You will need to have insurance for the collateral
When providing a car as collateral for a secured personal loan, the lender will require adequate insurance for the vehicle. This is because if the vehicle is damaged and you are unable to repay the loan, the lender may not be able to recover the funds they lent to you. When necessary, the lender will obtain the insurance, and the cost will be passed along to the borrower.
The insurance requirement varies from lender to lender. For example, if the collateral is jewelry, the lender may hold on to it until the loan is repaid. In such a case, you would not need to insure the jewelry.
The bottom line
Ultimately, a secured loan may be an accessible way to access credit for people who may otherwise not qualify for an unsecured personal loan. A secured loan has some advantages over an unsecured loan, such as a potentially higher borrowing limit and a lower rate of interest. However, the borrower must be sure of their ability to repay the loan as agreed to avoid losing the collateral.
Notice: Information provided in this article is for information purposes only and does not necessarily reflect the views of discapitalied.com or its employees. Please be sure to consult your financial advisor about your financial circumstances and options. This site may receive compensation from advertisers for links to third-party websites.
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