What Is a Secured Loan and How Does It Work?

A secured loan is a 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 the lender can recover losses through 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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Key Takeaways

• A secured loan is backed by collateral — like your home, car or investments.

• The lender can seize the asset if you don't repay the loan.

• Secured loans tend to offer lower interest rates, higher borrowing limits and longer repayment terms than unsecured loans because the collateral reduces the lender's risk.

• Compare your collateral's value and your credit profile before applying, and consider an unsecured loan instead if you need a smaller amount or want to avoid putting an asset on the line.

How Does a Secured Loan Work?

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

The collateral valuation is based on appraisals or market estimates — like Kelly Blue Book.

Loan-to-Value (LTV)

The secured loan lender will evaluate how much the asset’s value is compared to the amount you’re trying to borrow. If your LTV is lower, then your rates are more favorable.

Repayment Structure

You’ll be required to make monthly payments over a certain term. Missing payments can lead to 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 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 full amount of the 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 file a lawsuit to recover that amount.

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

The biggest difference between a secured and an unsecured loan is collateral. A secured loan requires collateral, while an unsecured personal loan doesn’t have this requirement.

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

Quick Example: Secured vs. Unsecured Loan Costs

Here’s a simple example that highlights the cost differences between secured and unsecured loans:

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 via Experian, TransUnion or Equifax. This should take 15 minutes.

2. Check the value of your collateral: You can look to Kelly Blue Book for your vehicle or get an appraisal for a home or other valuables. This could take a few minutes if it’s online, but longer if you need to get an appraisal.

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 will take less time than going 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 additional requests, it may take one to three business days or a week.

7. Understand the repayment terms: Make sure you understand the monthly payment amount, interest rate and loan length. This will likely take 30 minutes.

8. Sign your loan documents and get your money: It may take one to three 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 Takeaways

• A secured loan is backed by some type of collateral. It can be your home, a car, an investment or some other kind of valuable.

• If you default on your secured loan, the lender can seize your collateral.

• Secured loans often have lower rates than unsecured loans.

• An unsecured loan isn’t secured by collateral. Likely, the loan amount will be low and the interest will be high.

Secured Loan FAQs

What’s a secured loan?

A secured loan is backed by some type of collateral. If you default on the loan, the collateral can be seized.

Is a mortgage a secured loan?

A mortgage is a secured loan since the debt is secured by the house.

What can I use as collateral?

You can use your house, CDs, savings, a car or valuables for collateral.

Are secured loans safer than unsecured loans?

For lenders, a secured loan is safer since there’s some recourse if you default. For borrowers, secured loans often have lower interest rates.

What happens if I default?

If you default, the lender can accelerate the debt, seize and sell the collateral, and sue you for the balance that’s remaining on the loan. Your credit may also be damaged.

Karen Doyle contributed to the reporting for this article.

Photo credit: Drazen Zigic / Getty Images