A Guide to Secured Loans

In this guide, we’ll talk about several different secured loans, and the pros and cons of each so you know exactly what to expect before you borrow.

The different types of secured loans

Part II: Secured loans vs. unsecured loans

The pros and cons of secured loans

Staying safe with a secured loan

What happens if you can’t pay?

A secured loan is backed by an asset that you own outright, like a paid-off vehicle or the equity in your home. You put up that property as collateral, and a lender uses that collateral as assurance that they’ll get their money back if you don’t pay. In some cases, secured loans can be allotted for any purpose the borrower chooses.

For some secured loans, like high-fee payday or title loans, the barrier to entry is very low. Lenders may not require a credit check, and you can walk out with cash in just a few minutes. These usually fall under the category of predatory loans, and although they are easy to obtain and have short loan terms, they are difficult to pay back and escape.

For home and auto loans, borrowers usually have to demonstrate a minimum level of creditworthiness. Secured credit cards are a unique type of secured loan in that they don’t usually require a good credit history and instead are used primarily to build or repair credit on a low-limit card.

Type of loan

Collateral & other requirements

Rates and fees

Borrowing limits

The risks

Varies based on lender and creditworthiness. Commonly 12-30% APR plus annual fees of $0-50

Usually equal to the deposit amount

Missed, late or minimum payments can add up and damage credit

Varies based on lender, creditworthiness, and terms of loan. May have processing, maintenance, or appraisal fees.

Varies based on lender and creditworthiness. Usually equal to or less than the equity you have in your home

Variable interest rates with HELOC, foreclosure on home if loan goes into default

Average interest rate for a new car is 5.1%, for used is 8.72%

Varies based on lender and creditworthiness

Failure to pay can result in lender repossessing car

Average 391% APR plus fees of $10-30 per $100 borrowed

Varies by state, $500 is a common limit

High interest rates and fees to extend loans, potential overdraft of account, default and debt collection

Varies widely based on lender and vehicle value. These loans are typically for 15-30 days and have at least a 300% APR

Varies with state and lender. Some states set minimum and maximum amounts. Title loans aren’t legal in all 50 states

High interest rates, loss of vehicle upon default

Rates vary based on lender, creditworthiness, terms and down payment amount. Fees may include inspection and appraisal, attorney bills, closing costs and more.

Varies based on lender and creditworthiness. Approval may also depend on debt-to-income ratio and employment history. Best practice is to keep the total loan below 28% of income.

Taking on too-high monthly payments can result in default and foreclosure

To obtain a secured card, the borrower must put down a minimum deposit as collateral. The line of credit available for use is usually equal to the deposit amount, though in some cases it can be higher.

The borrower can use their secured card just like a normal credit card — and in order to build credit and avoid interest, he or she should manage the balance and payments responsibly. Minimum deposits for secured cards range widely from $49 to $750, and some carry annual fees up to $50 or more.

With a home equity loan or home equity line of credit, the borrower puts up the equity in his home as collateral — essentially, this means borrowing against the amount your home is worth minus your current mortgage balance.

HELs, like a traditional installment loan, are made in a set dollar amount with fixed payments over the life of the loan.

HELOCs, on the other hand, operate like credit cards. The borrower is approved for a dollar amount that he can draw against and pay off with a variable interest rate. These loans are often spent on home repairs but can be used for other major expenses like education, weddings, debt consolidation or in case of emergency.

In some cases, borrowers carry a zero balance for most of the life of their HELOC but feel secure knowing it’s available if the need arises. If the borrower defaults on a HEL or HELOC, the lender has the right to repossess and sell the home.

Payday loans are a form of lending in which a cash-strapped borrower receives cash with the promise of repaying the loan plus a fee on their next payday.

In this case, a postdated check for the total of the loan amount and fees or authorization to access the funds in your bank or prepaid account serves as collateral for the loan.

These small-dollar loans usually run on two- or four-week terms and although they are often for $500 or less, they carry an average 391% APR. This often traps borrowers in a debt cycle. According to recent research from the Pew Charitable Trusts, 12 million Americans take out these loans every year and spend $9 billion on fees alone.

Title loans require the borrower to turn over their car title in exchange for fast cash.

Most lenders don’t require a credit check, and though terms and requirements vary widely, these loans come with hefty fees and interest rates. If the borrower fails to pay back the loan, he or she can either take out another loan with additional fees, or risk having the lender repossess the car.

The Consumer Financial Protection Bureau found that between 2010 and 2013, 20% of borrowers had their vehicles seized by lenders, and more than half of borrowers took out four or more consecutive loans to repay their initial amount.

Like a mortgage, with an auto loan the borrower uses the property they are buying — a vehicle — as collateral to secure the loan.

The lender, usually a bank, credit union or dealership, holds a lien on the car until the loan is paid in full. Monthly payments vary widely depending on the price of the car, the length of the loan contract and the APR you receive.

This isn’t always the case, however — rates and terms vary widely depending on the lender and type of loan as well as the borrower’s credit history. For some, an unsecured loan may not even be an option, as lenders may offer only a secured loan to a consumer who is considered high risk. Borrowers may also prefer to put up collateral and get more favorable terms offered with a secured loan over an unsecured loan.

With both secured and unsecured loans, it’s important to know that nonpayment has serious consequences for your financial well-being. In addition to seizing collateral put up for a secured loan, lenders can send your unsecured loan debt to a collections agency and take legal action to recoup losses. Default puts your credit rating and access to future loans in jeopardy.

Secured

Unsecured

Collateral required?Yes

No

Credit requiredVaries. Title lenders may not require a credit check, while an auto loan or mortgage lender will

Yes — history and score vary by product and lender. Most federal student loans don’t require a credit check, however.

Cost of loan (APR, fees etc.)Varies with loan type. Interest rates for auto loans go as low as 5.2%, while rates for title and payday loans can hit triple digits. These also come with fees for rolling over to another loan at the end of a term. Secured cards have APRs ranging from 9% to 21.99% and annual fees of $0-50

Personal: Around 4%-35.99% APR with origination fees ranging from zero to 8%Student: Federal interest rates range from 4.45% to 7% plus fees between just over 1% and just over 4%. Private loans have variable rates, some high as 14.24%.Credit: APRs start around 6% and hit upward of 25%. May also have annual fees

ProsOpportunity to build credit and to borrow more than you might be approved for with an unsecured loan

Don’t have to put up collateral, helpful in emergencies, can be used for any purpose — especially to consolidate higher interest debt

ConsRisk of default and loss of collateral plus additional money and property, negative impact on credit

Higher APR and fees, risk of overspending and creating loan dependency, damage to credit if you can’t afford payments

Best for (what type of consumer)Depends on loan. Secured cards help build (or rebuild) credit history, while payday and title (predatory) loans are not recommended

Consumers looking to consolidate high-interest debt or purchase big-ticket items they’ve planned for IF they can afford the monthly payments

Secured loans — aside from predatory payday and title loans — are available from a variety of lenders. If you already hold accounts at a bank, this would be the first place to look. Credit unions also offer secured loan services, though you must be a member to access their products. Finally, look at online, nonbank lenders who focus on loans without offering traditional banking products. No matter what type of loan you’re looking for, shop around to ensure you get the best rates and terms.

When it comes to choosing a secured loan over an unsecured loan, there are some benefits and risks to weigh.

Secured loans may allow you to get more money with less credit. Lenders are often more willing to lend higher sums to consumers if the loan is secured by collateral because they have something tangible to repossess or foreclose on if the borrower defaults, according to Andrew Chan, a financial adviser at Locker Financial Services, LLC in Little Falls, N.J. Because this is a lower risk for lenders, they may also be more willing to forgive lower credit scores.

Secured loans often have lower interest rates and fees than unsecured loans.Because secured loans pose less risk to the lender, the borrower may be offered lower rates, fees and payments, says Chan. This may give you access to the cash or credit that you need but may not otherwise get — if you use it responsibly.

The collateral you put up is always at risk.Even with the best-laid plans, taking on a secured loan means that your personal property may be repossessed. If you default, your lender can take your collateral, sell it and repay the loan with the proceeds. As the borrower, you lose amount you already put into the loan plus valuable property that may be difficult to replace.

Lenders may trap you with prepayment penalties and other fees.Even if you want to get out of your secured loan and have the ability to pay off what you owe, you may get hit with prepayment penalties — fees that lenders charge borrowers who repay loans before they are due. If you do pay off a loan early, the lender makes less in interest, so they may try to keep you in a costly loan by making it too expensive to leave. With predatory lending, loan fees can quickly add up each time the borrower tries to extend the loan.

An important part of taking on any loan or form of credit, secured or not, is knowing that you can handle the payments over the life of the loan and continue to afford other financial obligations. Here are five factors that may impact your ability to manage your loan:

Job security. Some secured loans, like HEL and mortgages, are long-term commitments (20 to 30 years) . Even if you have the income to cover your loan payments and still live comfortably now, think about whether your current career and employer offer enough stability to do so down the line, as well as whether you have marketable skills to find other opportunities next month, next year, or far in the future if necessary.

Cash flow. Just because you are able to put up property as collateral doesn’t mean you’ll be comfortable making payments on your secured loan. Look carefully at your income and expenses to determine if the monthly payments, interest and fees on your loan are actually within your budget, both now and (as much as possible) in the future.

Lifestyle. Even if you have the cash, the burden of taking on a loan could impact your ability to live the way you want to, says Johnna Camarillo, assistant vice president of equity processing and closing at Navy Federal Credit Union.

“Make sure that you don’t put yourself in a situation that according to the numbers, I can comfortably make my payments, but I can’t take a vacation or I can’t go out with my family as much as I’d like,” she told MagnifyMoney. “People should really look at their total lifestyle and look at how much disposable income they want.”

Future expenses. If you have kids (or plan to) and want to pay for college, aspire to buy a home or are close to retirement, this may impact your ability to continue to make loan payments. Plus, if you default on a secured loan, lose your property and damage your credit, it will likely be difficult to restore your financial situation to the point where you can afford these investments.

Total interest and fees. When you shop around for a secured loan, look at the total cost you’re on the hook for over the life of the loan — especially when you put up collateral you don’t want to lose.

“Sometimes people get attracted to a low monthly payment, and they’ll stretch it out over 15 to 20 years, but they don’t realize the impact that has on the amount of interest that they pay,” Camarillo said. She recommends looking carefully at interest rates, transaction and maintenance fees, as well as any fees associated with entering and exiting your loan.

When it comes to managing a secured loan, having all the information and planning carefully for the long term is key. Don’t jump on what seems like a good deal without shopping around and budgeting, and don’t sign for a loan without understanding the risk to your property and your overall financial health.

If you get in over your head with any kind of loan, the first thing to do is talk to your lender. If you are a member at a credit union or a long-time customer at your bank, your loan officer may be able to help you with a plan to get back on track. Even payday lenders may be willing to work out an Extended Payment Plan (EPP), which allows borrowers extra time to cover their outstanding debt without added fees or risk of being sent to collections. You can also find ways to free up funds in your budget by cutting expenses large and small.

If you aren’t able to make payments and your loan goes into default, however, there are serious consequences.

Your credit takes a hit.Payment history is the single most important factor in your FICO credit score — it accounts for 35% of the total. It is also considered “extremely influential” in the VantageScore model. Scoring models take into account bankruptcies, foreclosures and missed/halted payments, and having any of these in your credit history can have a long-lasting impact on your ability to apply for credit in the future. Even secured cards, which are primarily used to build and improve credit, can backfire if not managed properly.

You end up on a debt spiral.Defaulting on a loan can quickly put you into a cycle of debt that is difficult to break, especially if you are caught in a predatory lending situation. These lenders operate by charging interest rates and fees so high that the borrower is unable to make a dent in the loan principal and continues to take out additional loans just to pay the excess that accrues.

Auto title loans are “incredibly dangerous” because borrowers continue to pay fees to extend and end up paying out far more than they expected or planned for, says Saunders. “They’re not getting out of debt, and eventually many people not only lose all that money they paid but they lose their car.”

You lose your collateral—and possibly more of your assets.If you default on a secured loan made with physical property as collateral, there’s a good chance you’ll lose that item at the very least. A lender may repossess your car, foreclose on your home or come after the boat, motorcycle or other valuable property you put up. If it’s something that diminishes in value, what the lender sells it for may not cover the full amount of the loan, in which case they may come after you for the difference, says Chan.

“Although the lender may be willing to offer higher loan amounts with a secured loan, consumers still need to make sure that they can afford the monthly payments associated with the higher loan amount,” he added.

Experts agree that the biggest risk with a secured loan is losing property you already own. When you put your home, car, paycheck or savings on the line, you must understand the consequences of default — especially if you are already in a difficult financial situation.

“The overarching theme is, ‘Can you afford to lose the collateral?’” said Saunders. “How catastrophic would it be for you if you lose the collateral? You shouldn’t put it at risk if you can’t afford it. You shouldn’t pawn your wedding ring, but you might be willing to pawn a TV.”