What Is a Secured Loan and How Does It Work?

A secured loan is a personal loan that’s backed by collateral - something tangible the lender can take if the loan isn’t paid. A common example is a mortgage, where the home itself secures the loan.

Because lenders can recover losses from the collateral, secured loans typically come with lower interest rates than unsecured loans. But that also means you’re putting your asset at risk if you fall behind on payments.

Here’s what to know about how secured loans work and whether they’re the right fit for you.

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How Does a Secured Loan Work?

A secured loan is backed by collateral. A lender considers your borrower profile alongside the asset’s value. The borrower profile can include credit score, income and existing debt.

When you take out a secured loan, you pledge something of value, most often a house or a car, though it can be savings or other valuables, as a guarantee to the lender. This pledge is what makes the loan “secured,” because the lender has a fallback if things go wrong.

The catch comes if you can’t keep up with repayments. Because you’ve pledged collateral, the lender has the legal right to seize and sell that asset to recover what you owe - this is why a car can be repossessed or a home foreclosed on when the borrower defaults.

Loan-to-Value (LTV)

The lender will evaluate the asset’s value relative to the amount you want to borrow. If your LTV is lower, then your rates may be more favorable.

Repayment Structure

You’ll be required to make monthly payments over a certain term. Missing payments can lead to the repossession of the asset.

What Types of Secured Loans Are There?

There are several types of secured loans, from personal loans to title loans. Each comes with its own features and use cases.

What Can Be Used as Collateral?

Here are some of the most common types of collateral and what to consider for each:

Savings or CD Accounts

• Pro: Low risk of rejection by lenders

• Con: Funds are locked until the loan is repaid

Paid-Off Vehicle

• Pro: Fast approval and access to funds

• Con: Risk of losing transportation if you default

Home Equity

• Pro: Lower interest rates

• Con: Risk of foreclosure if you fail to repay

Investments

• Pro: Potential tax efficiency

• Con: Market downturns may trigger a margin call

What Happens if You Default on a Secured Loan?

Defaulting on a secured loan can have serious consequences. Here’s what to expect:

• Acceleration of debt: Typically, after 30 to 90 days of nonpayment, the secured lender will accelerate the entire debt.

• Collateral will be seized: The lender will take the asset secured by the debt. They will take your car, home or savings.

• You owe the deficiency balance: The lender will likely sell the collateral and apply whatever amount is received toward the debt. You must pay the remaining amount due.

• The lender may file a lawsuit: To collect that deficiency balance, the lender may sue you for the remaining amount.

Secured vs. Unsecured Loans: What’s the Difference?

The biggest difference between a secured and an unsecured loan is the presence of collateral. A secured loan requires collateral, while an unsecured personal loan, sometimes called a signature loan, doesn’t.

Here’s a side-by-side look at secured vs. unsecured loans:

Pros and Cons of Secured Loans

Secured loans can offer benefits, but they also come with risks to consider:

Pros

• Lower interest rates

• Easier to qualify, even with bad credit

• Can borrow more money

Cons

• Risk of losing your collateral

• May have a longer application process, including appraisal of collateral

• Not ideal for small loan amounts

How To Apply for a Secured Loan

Applying for a secured loan is a straightforward process. Here’s how it works:

1. Check your credit: You can pull your credit report from the major credit bureaus (Experian, TransUnion or Equifax) and check your credit score for free online.

2. Check the value of your collateral: You can get an appraisal for a home, vehicle or other valuables. This could take a few minutes if it’s online, but longer depending on the lender's requirements.

3. Compare lenders: Consider the best banks, online lenders and credit unions to decide which is the best for you. Depending on how much research you do, it could take 30 minutes to a few hours.

4. Gather documents: You’ll need an ID, proof of income and documentation of collateral. This could take a few hours, depending on how accessible the documents are.

5. Apply online or in person: Applying online typically takes less time than applying in person. If you have all the documentation, it could take 30 minutes to an hour.

6. Comply with any additional requests from the lender: Depending on the requests, it may take one to three business days or up to a week.

7. Understand the repayment terms: Make sure you understand the monthly payment amount, interest rate and loan length.

8. Sign your loan documents and get your money: It may take one to five business days to receive funds.

How Do You Decide if a Secured Loan Is Right for You?

A secured loan is the right choice in some, but not all, situations. It can also help to compare it with other types of personal loans, depending on your needs.

Good Fit If

• You need a large loan

• You have collateral

• You have fair or poor credit

Not Ideal If

• You have no valuable assets

• You want quick, unsecured cash

• You have very good or excellent credit

Key Terms

• Secured loan: A loan that requires you to pledge an asset as collateral. The lender can take that asset if you fail to repay as agreed.

• Collateral: An asset, such as a home, vehicle or savings account, you offer to back a loan. It reduces the lender's risk and can help you qualify for lower interest rates or larger loan amounts.

• Loan-to-value ratio (LTV): A measure of how much you're borrowing compared to the appraised value of your collateral. A lower LTV signals less risk to the lender and can result in more favorable interest rates.

• Default: Failure to repay a loan according to its terms. For most secured loans, default is triggered after roughly 90 days of missed payments.

• Foreclosure: The legal process a lender uses to take ownership of a home when a borrower fails to repay a mortgage or home equity loan.

• Deficiency balance: The amount still owed on a loan after the lender sells the collateral and applies the proceeds toward the debt. The borrower remains responsible for paying the remainder.

• Repossession: The process by which a lender reclaims a financed asset - typically a vehicle - when a borrower stops making payments.

• Unsecured loan: A loan that doesn't require collateral. Approval is based on creditworthiness, and interest rates are typically higher than on secured loans.

Sources

• Consumer Financial Protection Bureau: What is a mortgage?

• Consumer Financial Protection Bureau: What is a home equity loan?

• U.S. Department of Housing and Urban Development: Avoiding foreclosure

Karen Doyle contributed to the reporting for this article.

Jasmin Baron, CCC™, contributed to editing this article.

Photo credit: Drazen Zigic / Getty Images

Parts of this article were created with AI assistance. MoneyLion editors reviewed, fact-checked and edited the final version and are responsible for its accuracy.