A secured personal loan is one that is guaranteed by collateral in the form of personal assets you own. Lenders can take possession of these assets in order to recover their funds if the borrower defaults on the loan. This acts as an incentive to the borrower to repay their loan on time. As a result of having this security, lenders can provide lower interest rates to borrowers on secured loans.
Types of secured personal loans
- Home loan or mortgage. Under this type of loan, lenders take a charge over a borrower's home or other property as collateral. If a borrower defaults on a loan or consistently fails to make monthly repayments, the home may go into foreclosure. The two main types of mortgage loans are lump-sum home loans and home equity lines of credit.
- Car or other vehicle loan. This is one of the most common loan types used by individuals or small business owners. Cars, motorcycles and boats may be offered as collateral. Similar to mortgage loans, failure to repay a secured loan can cause your vehicle to be repossessed by your lender.
- Home renovation loan. To increase the value of your home you might want to upgrade its existing rooms or create additional landscaping (such as a swimming pool or garden). However, not every prospective homeowner will find themselves in the appropriate financial situation to renovate a home. To achieve your home renovation goals at lower interest rates, considering a secured loan is your best option. In this case, the home in question may be used as collateral.
- Loans for other purposes. Secured personal loans can be used to finance almost any other purpose of your choice, including holidays, weddings, education and debt consolidation. Although these types of loan are typically offered as unsecured loans, you may be able to get a lower interest rate by offering security.
When to consider a secured personal loan
Because you put yourself at risk of losing your property or vehicle under a secured personal loan, you may be wondering why borrowers choose to get them in the first place as opposed to a standard personal loan. If you find yourself in a financial situation similar to any of the ones listed below, you may be better off applying for a secured personal loan rather than an unsecured personal loan:
- Bad credit. If you don't qualify for an unsecured personal loan because of your credit score or lack of credit history, you may still be eligible for a secured loan. You may even use this loan to improve your credit score by paying off multiple debts and bills using a debt consolidation loan.
- High debt-to-income ratio. Similar to the previously mentioned circumstance, you can still qualify for a secured personal loan even with a high debt-to-income ratio. Your debt-to-income ratio is calculated by dividing your total monthly debt payments by your gross monthly income, then multiplying the result by 100 to arrive at a percentage. Borrowers normally want to see a debt-to-income ratio of less than 40% before they will advance further loan funds.
- Higher loan amount. If you need to borrow a particularly large amount, a secured personal loan may give you more options.
Features to check when comparing secured personal loans
When applying for this type of loan, you'll most likely source the product from a bank, online lender or credit union. The interest rate you are offered will depend to some extent on the lender you work with, along with a review of your credit history and an appraisal of the proposed collateral, but you should also consider the following important factors:
- Loan terms. Secured loans are suitable for those who need a longer amount of time to pay off their loan. If you're capable of repaying your loan over a shorter period, keep in mind that though you can leverage a lower interest rate, you'll likely have to satisfy higher monthly payments.
- Collateral assets. You can't just offer any item as collateral. In some cases, for example, one lender may only accept real estate or a paid-off vehicle , whereas others may be more flexible and accept a savings account.
- Associated fees. As with any type of loan, note that you won't just be paying interest. There may be additional fees attached, such as an application fee, a charge for appraisal of the offered collateral, and ongoing monthly or annual fees for loan account administration.
- Comparison rate. To determine the true cost of your loan, ask your lender to provide a secured personal loan comparison rate. A comparison rate comprises of the interest rate of your loan along with other related charges. However, a comparison rate won't include every fee you may be charged (such as late payment fees) so it won't always reflect the final, most accurate cost of your loan. Instead, comparison rates make for an excellent guideline for possible costs.
Assets acceptable as secured personal loan collateral
To guarantee that the loan is repaid, lenders must ensure that your collateral is valuable enough to encourage you to meet monthly repayments on time and thus avoid repossession. Lenders may therefore make an appraisal of the collateral you offer before approving your loan application. Though they hold a legal interest in your asset, it will remain under your physical control (unless you default on your loan and the asset is repossessed). Here is a list of the assets you can use as collateral:
- Real estate property. This may be a house, land, an apartment or commercial property. There may be an existing mortgage on the property, but if you have substantial equity in it, the lender may be prepared to take security in the form of a second mortgage.
- Vehicles. If you own a car, boat, truck, motorcycle or other means of transportation, you can use this asset as collateral. In most cases, lenders may require you to have comprehensive insurance cover to protect the vehicle.
- Shares. Investments in shares, debentures and other financial instruments may be acceptable as security.
- Cash deposits. A good balance in a bank savings account or term deposit could be used to secure your loan. Just bear in mind that the interest rate you pay on your loan will almost certainly be higher than the rate you are receiving on your deposit.
- High-value items. If you own a product of larger significance such as jewellery, artworks and collectibles, these can count as collateral.
Secured personal loans vs unsecured personal loans
Though an unsecured personal loan may seem preferable because the lender doesn't hold any rights over your property or assets should you default on your loan, there are several advantages secured personal loans have that unsecured ones don't. These include the following.
- Collateral. The most obvious difference between secured loans and unsecured loans is the demand of the former for collateral. By putting up valuable assets to secure your loan, you are more likely to have your loan application approved.
- Risk. While lenders absorb less risk than you do, putting up collateral tends to encourage borrowers of this type of personal loan to make their repayments on time.
- Interest rate. Secured loans have lower interest rates than unsecured personal loans.
- Repayment period. Unsecured loans cater to longer repayment periods. This is because some types of property can appreciate in value, which adds to the collateral of the loan as it is repaid. However, early repayment can incur penalty fees.