What Is a Secured Loan and How Do They Work? · The Penny Hoarder What is a Secured Loan and How Do They Work?

A secured loan is a type of loan backed by collateral that your lender can seize if you don’t make payments. A mortgage is one of the most common types of secured loans. Your home is the collateral. If you don’t make your mortgage payments, your lender will start the foreclosure process to seize your home.

Most personal loans are unsecured loans, meaning they aren’t backed by assets you own. But if you have bad credit or a limited credit history, your lender may require you to put down collateral in order to borrow money.

In this article, we’ll explain what is a secured loan, the differences between secured vs. unsecured loans and the pros and cons of a secured loan.

What Is a Secured Loan?

A secured loan is a type of loan where you pledge financial assets as security so that a bank or credit union will lend you money. If you don’t make payments according to the loan contract, the lender can take those assets. A secured loan can be backed by assets like real estate, a vehicle, savings account, cash deposit or business inventory.

Secured loans are commonly used to finance major purchases, like a home or vehicle. But it’s also possible to obtain a secured loan for virtually any purpose.

Suppose you need to borrow $5,000, so you apply for a personal loan. But because you have a low credit scoreyour bank requires collateral. Let’s say you own your car outright, and it’s worth $10,000. You could use your car as collateral to get a secured personal loan. The bank will put a lien on your car (or any other asset you’ve pledged), which gives it a legal claim to the financial asset.

There’s less risk to the bank. If you fail to make monthly payments, the bank can take possession of your car and sell it. But the risk is greater to you because you could lose your car if you default. If you use that car to Commute to and from work or for business, you could jeopardize your financial health.

But as long as you repay the entire loan…

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