What are secured loans?

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A secured loan is a type of financing, in which an asset with marketable value is pledged by the borrower to the lender – as collateral for the loan.

The security for the loan will be defined in the loan agreement, promissory note or loan contract. The secured loan agreement also describes the planned disposition of the collateral should the loan go into default.

A secured loan is in contrast with an unsecured loan. An unsecured loan requires no asset be pledged to the lender as part of the loan agreement – as long as the borrower is acceptable to the lender.

Secured loan and loan risks

For lenders, the main difference between secured and unsecured loans, besides the collateral, is the risk involved. With unsecured loans, the risk is usually higher for lenders. If the borrower defaults on an unsecured loan, the lender has limited options for getting their money back.

Secured loans, on the other hand, are considered less risky for most lenders. If the borrower defaults on a secured loan, the lender can use the security to recover the loan proceeds and minimize its losses.

Because it offers a relatively lower risk exposure for lenders, a secured loan is usually easier to qualify for – especially when compared to an unsecured loan. A lender making a secured loan has a legal, defined interest in the collateral being pledged and can seize or repossess the pledged asset should the loan go into default.

One of the most common forms of secured lending is the automobile loan. When an automobile lender makes a loan to a car buyer, that car loan lender receives an ownership interest in the automobile until the loan is retired. Although the vehicle owner keeps possession and use of the car, the lender typically holds the title to the car, as security for the loan. Once the automobile loan is completely paid off, the lender will transfer the car title to the car owner and will no longer have any legal interest in the car.

Car title loans, also called title pawns or pink slip loans, work the same way. However, automobile repair financing may be either secured or unsecured.

Secured loans and defaults

If the borrower falls behind in payments to the lender the lender may establish a repayment agreement to help the borrower catch up on payments. However, a repayment schedule is considered and granted by the lender, and the lender is typically under no obligation to establish a repayment plan.

If the borrower fails to make the agreed upon payments the lender can seize, or repossess the automobile. The borrower is typically granted a period of time to catch up on the past due amounts and get the car back. However, if the borrower cannot make up the past due amounts, the lender may sell the automobile to a third party and use the sale proceeds to pay off the loan balance.

If the automobile is sold for an amount equal to the loan amount, the issue is settled (though the damage to the borrower’s credit history will remain for at least seven years). If the post-repossession sale results in surplus cash, the lender usually must return that extra money back to the borrower. If the automobile is sold for less than what is owed, however, the lender may continue collection efforts against the borrower to recover the remaining balance owed.

A secured loan does not have to require that the security be placed upon the item being financed or purchased. For example, a bank can issue a secured loan to a borrower and have the borrower pledge a certificate of deposit or other financial asset as part of the loan agreement.

For individuals who wish to establish a credit profile or repair damaged credit, a secured loan offers an opportunity to get credit that can be used to add positive credit entries into one’s credit history. It’s easier to qualify for secured loans, even with less-than-perfect credit. Once that secured loan or credit card is approved, smart use of that credit can then help the borrower start building or rebuilding credit scores.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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