What Are Secured Loans & How Do They Work?

What is a secured loan?

Updated: December 30, 2023
Matt Crabtree

Written By

Matt Crabtree

 

Home mortgages and equity loans are typical examples of secured loans. You can use them to “secure” a loan by putting them up as an asset — also called collateral.

To entice you to take out a secured loan, lenders often tell you that you would just have to make “one manageable monthly payment” instead of many. But secured loans may be costly, and you might lose your house if you default. 

To sum up, they are a financial nightmare that should be avoided at all costs. This guide's primary goal is to assist you in locating less expensive options. However, if a secured loan is what you want, we'll show you where to go for the best rates.

Key Takeaways

  • As our intro implies, we’re not fans of unsecured financing. You should always look at other options before settling on it. 
  • Personal loans are significantly cheaper and less dangerous than consolidation loans, so if you're having trouble keeping up with your current bills, you may want to look into applying for one. 
  • Only use a secured loan to get the money you need if the money will be used towards something that will increase your home's worth. If so, a mortgage broker can help you weigh your alternatives for getting that money out of your home at a lower cost.
  • NEVER put your property up as collateral if the money you need won't be used to improve it. Rather, try to secure a personal loan. 

What is a secured loan?

When you take out a secured loan, you pledge an asset (like your house) as collateral. Homeowner loans are secured by the borrower's residence; hence, those without this kind of collateral cannot get that loan.  

Security is a nice idea in theory, but…

Loans that are secured benefit the lender rather than the borrower. A standard unsecured personal loan is far preferable than a home equity loan in almost every circumstance.

Most importantly, understand that your lender may seek a court order to sell your house to recoup any money it is due if you fail to or are unable to repay the loan.

Borrowing money against your assets is risky business and should only be done as a last option. Personal loans, low-interest credit cards, or even a mortgage extension are better options for those with good credit since they are more flexible and can be used in a wider range of situations than payday loans.

How do secured loans work?

Where do secured loans come in? These are options for homeowners and even sole proprietors who want to use their business as security.

The collateral for a secured loan is the property itself. If you are unable to keep up with the mortgage payments, the lender has the right to sell your property (repossess it). single-business owners 

If you need to borrow a large quantity of money, a secured loan may be your best option. Interest is often expressed as a percentage of the loan balance and may be either fixed or variable. 

Mortgages are usually secured loans, meaning you put down an initial payment and borrow the rest of the money you need to complete the purchase of the home. 

Another example of a secured loan is a mortgage, which serves as collateral for the loan. It's possible that a house loan may be your first and only secured loan, or that it will be added to an existing mortgage. To finance, for instance, a house addition, a mortgage may be considered.

Likewise, you can use a car itself as collateral for a secured car loan.

Are unsecured business loans possible?

Yes, as mentioned earlier, secured and unsecured business loans are also available. 

One example of a secured business loan is financing for machinery and tools. Let's pretend you're the owner of a construction company in need of a new dump truck. A loan secured by the dump truck you want to buy might be used to cover the cost. You won't have to worry about losing the machinery you bought as long as you keep up with your loan payments. 

It's important to remember that a personal guarantee may be needed in addition to the collateral for a secured business loan. If the company fails to make its loan payments, you accept personal responsibility for the debt. If your company has cash flow problems, for instance, you may face personal liability for a loan default.

Why do some people choose secured loans?

Who needs a loan that is guaranteed by collateral? As you may have guessed from the introduction to this article, we do not recommend that anybody apply for or get one of these loans. However, they are still purchased by many because:

Typically, you can borrow more money.

A secured loan often allows you to borrow more money than an unsecured loan.  However, your ability to borrow money will be affected by factors such as:

Your loan-to-value (LTV) ratio, or the size of the loan in relation to the value of your house, may also play a role in determining the maximum loan amount you qualify for. If you want to know how much house you can afford, a mortgage calculator might help.

The average interest rate is lower

Since the lender or lending institution already has some kind of collateral to fall back on with a secured loan, the interest rate may be negotiated down to a more reasonable level. However, the interest rate a lender is prepared to provide may be affected by a number of variables, including the amount of the loan, the equity you have in your house, and your credit score.

Credit scores have less of an impact on secured loans

For borrowers with less-than-perfect credit, home-secured loans may be a more viable option than unsecured ones. However, you won’t be approved for a loan if the lender thinks you'll have trouble making your payments on time. 

Check your credit record and raise your credit score as much as possible before applying. A higher credit score raises your mortgage approval odds and influences the discounts you're provided.  

They are also more accessible. The interest rates on unsecured loans tend to be lower for borrowers with better credit, but the protection provided by secured loans makes lenders more willing to work with borrowers who have lower credit ratings.

That said, it is possible to borrow more money. While the most you may borrow on an unsecured loan is £50,000 (or £25,000 with certain lenders), the highest you can borrow on a secured loan is £100k (or more, depending on your equity in and the value of your property).

In this case, the loan term may be extended. Secured lenders choose longer loan terms (typically between 5 and 20 years) to help compensate for costly initial investments. As a result, they are able to dangle the carrot of reduced monthly payments in front of consumers who may otherwise be tempted to default on their mounting debt. But…

Don't let the promise of “affordable payments” fool you. Extending the term of the loan in order to lower the monthly payment might significantly raise the total interest paid.

In general, the lower the interest rate, the lower the monthly payment. However, interest accrues at a much faster rate the longer a loan is outstanding for.

Due to this, secured loans are not a simple solution for those with substantial debt, despite what some flashy TV advertising may have you believe. A house is not a game piece. There is no other purpose served by these loans.

Advice for borrowers thinking about getting a secured loan

If you are unable to make your loan payments, you may lose your house.

Your credit score and future borrowing options may be severely impacted by any missing or late payments. You face the danger of not only defaulting on the loan, but potentially losing the house you used as collateral. Determine your maximum mortgage payment by factoring in all of the expenditures associated with house ownership. 

Use a mortgage calculator to estimate your monthly payments and their potential influence on your finances.

Interest rates on secured borrowing may fluctuate.

No matter what happens to interest rates in the market, a fixed-rate mortgage should keep your monthly payments the same until the loan term expires. However, if you have a mortgage with a variable interest rate, your payments may go up or lower depending on the direction of the interest rate.

Better substitutes for a secured loan

We don't believe anybody should use a secured loan, as you've already guessed by now. 

For this reason, we've compiled a list of other strategies that may help you acquire funds or reduce the interest rate on your current obligations. Depending on your status, the checklist will appear as follows:

  • Reducing the interest rate on outstanding obligations.
  • Needing more financing.

I'm aiming to reduce the total interest paid on all my bills.

Okay, so you should explore the following alternatives to a secured loan before deciding that this is the best course of action.

1. Using your savings. Paying off debts with savings makes sense since interest paid on savings is often much less than interest charged on borrowing. A “rainy day fund” is recommended by conventional wisdom. This decision is up to you. 

One argument is that it balances out anyway. Don't throw away your credit cards after paying off your obligations; instead, keep them locked up and use them only in case of an absolute financial necessity.

If nothing bad occurs, you'll be ahead of the game and able to put some money aside for a rainy day. If it does, then using the cards will leave you no worse off than before, but the interest savings will be enormous. 

2. Transfer a balance. One way to reduce the cost of credit card debt is to move the balance from a high-interest card to a 0% APR card. Find out more detail by reading the article on how to transfer a credit card balance

3. Shuffling credit cards. You can also reduce your interest rate on your current loans without purchasing any new items at all. Transferring balances from other cards to your credit card may often result in lower interest rates for you. Money could be saved significantly by reorganising debts and paying off the most costly ones first. The whole story of the “Credit Card Shuffle”.

4. Lends without collateral are the fourth kind. For those who can afford it, unsecured personal loans are a far better option because of their lower cost and lower danger. They may be used for debt consolidation in the same manner as a secured loan would. 

I'm trying to secure some more credit.

Alright, so you need more cash? In that case, a secured loan should under NO circumstances be considered. Instead:

1. Reduce expenses and stick to a budget. Everyday expenses may be reduced by a significant amount. Get your finances in order with the Money Makeover and then use the Budget Planner to make the most of your money. Put the extra money to good use instead of taking out a loan. 

Try to secure a personal loan if you can. For those who can afford it, they are a far better option because of their lower cost and lower danger. You may use them in the same way you'd use a secured loan to take out more money, however the maximum amount you can borrow is generally about £25k. 

2. A second mortgage. This is something to think about just if you want to use the additional funds you are borrowing for home improvements, such as an addition or a new kitchen. If so, you may want to consider taking out a second mortgage on your home or switching to a new mortgage with a lower interest rate.

DON’T get a mortgage or a secured loan if you need money for anything else.

No other options? Here’s how to evaluate secured loans

If you've read this far, we have one more appeal to make before you abandon the other choices.

  • Trouble keeping up with your current debts? You can acquire a personal loan, which is both less expensive and hazardous, or you can seek free debt counselling from a nonprofit credit counselling service. 
  • Home renovations need a loan? Find out whether you may borrow additional money from your mortgage lender (or a mortgage broker). 

Secured loans shouldn't be taken out for new borrowing or purchases; instead, they should be used for debt consolidation if doing so would result in a lower interest rate and monthly payment.

Whether you have 20 different loans or just one, paying them off as fast as possible and with as little interest as possible should be your first priority. Here are the steps to take…

  1. The first step is to get a grasp on your current debts by writing them down. 
  2. Look at the rates offered by reputable lenders for secured loans.
  3. If the interest rate on your other obligations is greater than the rate on your secured loan, then you should only use the secured loan to pay them off.
  4. Borrow just what you need and pay it back as soon as possible (while keeping any early repayment fees in mind).

It's important to realise that a broker will try to pair you up with a lender that can assist you get a secured loan virtually often. Keep in mind that broker costs on secured loans may be as much as 12.5%, which can translate to thousands of dollars and add significantly to your interest payments.

So, before signing anything, inquire as to the broker's costs (which may differ depending on the lenders they deal with).

The following websites will show you sample rates for secured loans based on the amount you need and the time you can afford to repay over.

  • Uswitch
  • Go Compare
  • Compare The Market

Although consulting with an independent financial advisor (IFA) will cost money up front, it might wind up saving you a lot of cash in the long term. Financial advisors should be consulted for further information and assistance. 

Can I get a secured loan without having a previous banking relationship?

The answer to this question is loan type dependent. 

You need to have an existing account with the financial institution if you want to apply for a loan backed by your shares or savings. 

However, you may still be able to apply for a business loan, mortgage, or vehicle loan even if you don't have an account. It's possible that the bank where you currently have accounts offers more competitive interest rates.

Verdict: What are secured loans & how do they work?

Extended payment plans are standard for secured loans. 

Since the lender faces less risk while providing a secured loan, the interest rate is frequently lower. However, keep in mind that if you are unable to make the loan payments and go into default, you will lose the collateral. Before agreeing to a loan, be sure you can afford it.

Mortgages are often signed for several years. A secured loan may have lower interest rates than an unsecured loan, but it may take you 25, 30, or even 35 years to pay it off. In the long run, this will result in higher interest costs. 

Prior to securing debts against your property, give it some serious thought. If you are unable to keep up with your payments, your property may be repossessed.

Related Guides:

What are secured loans & how do they work: FAQs

Is it possible to pay a secured loan off early?

What are the requirements to get a secured loan?

Is it simpler to receive a loan if you have collateral to put up?

If I can't pay back a secured loan, what options do I have?

Can it be cost-effective for me to get a secured loan?

When applying for a secured loan, what factors should I take into account?

How do they determine my interest rate?

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