Secured Loans Meaning Example Bad Credit What Is It

Secured Loans Meaning

Secured loans refer to the type of loans approved and received against a guarantee or collateral. If they fail to do so, the lending institution acquires the collateral to compensate for the amount that the borrowers were allowed.

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Secured loans can be obtained for business purposes and personal requirements. It is different from their unsecured counterparts, only approved based on the borrowers’ credit score. Common types of collateral-backed loans are mortgage loans, car loans, secured credit cards, pawnshop loans, life insurance loans, etc.

How Do Secured Loans Work?

Secured loans are called so as the lending institutions, be it a bank or a private lender, secure the loan amount against collateral. Collateral is an asset or set of assets that back borrowers’ promise to repay the loan amount within the specific period. As a result, the financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more acquire the assets that borrowers offer as a guarantee for repayment in the event of default.

Key Takeaways

Secured loans are finances that the lenders offer against collateral or security at a comparatively reduced interest rate.The types of collateral considered by banks or private lenders include real estate property, life insurance policies, stocks, assets, etc.The collateral-based loans are approved fast, given the repayment guarantee that lenders already receive in the form of security.These loans against security are meant for personal and business purposes and are mainly preferred when the funds required are high in value.

In short, the collateral tends to be the condition that, when found satisfactory, allows lenders to approve the borrowers’ loan application. Collateral/security can be anything, from real estate property to a bank account to stocks and assets to life insurance policies, etc.

Such collateral-based options are available for large loan amounts, which borrowers are likely to default on. The only aim of such loans is to ensure that lenders recover the lent amount irrespective of the financial crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more or other struggles the borrowers might go through. A loan seeker is expected to pay the installments at regular intervals. If borrowers are unable to pay back, their asset or collateral acts as a security. The lenders can use it to get back their lent amount in such events of default.

In short, collateral-backed loans assure the lender of repayment even if the amount is too huge. As a result, people with poor credit ratings can also take secured loans for bad credit for their personal or business purposes. Moreover, borrowers are likely to receive a loan at a much lower interest rate due to this assurance.

Features

#1 – Collateral-Based

The secured loans are collateral-based, i.e., the funds are lent against security to secure lenders. Thus, the borrowers use an asset/property as collateral to back the loans. In most cases, however, the borrowers use the same house or car to secure the loans they take up loans to purchase. This arrangement helps buyers buy assets/equipment easily, and at the end of the day, the lender also remains secure.

#2 – Lenient Interest Rate

The interest rateInterest RateAn interest rate formula is used to calculate loan repayment amounts as well as interest earned on fixed deposits, mutual funds, and other investments. It is also used to calculate credit card interest.read more is comparatively lower given the guarantee against repayment that lenders receive from borrowers. Thus, borrowers have to pay less interest than an unsecured loan.

#3 – Large Amount

Most people apply for collateral-based loans when they require borrowing a significant amount. And when the amount is higher, lenders need assurance for repayment. Hence, the borrowers back the loan amount with an asset to ensure the lenders are less worried about the huge amount and its payment terms.

#4 – No Purpose Restrictions

These loans are available for both personal requirements and business purposes. Hence, your purpose doesn’t determine whether you will be allowed to take the finance. However, the terms and conditions for secured loans for business are a bit different. Since the businesses have more money to pay off, the loan amount is usually higher than housing and car loans. Therefore, a business must let the bank/financial institution use one of its assets/machinery/furniture/raw materials as collateral for the loans.

#5 – Faster Approval

As the loan is collateral-based, lenders focus on is the property kept as a security against the lent amount. Thus, the application or credential verification takes a backseat, making the approval process faster.

Advantages & Disadvantages

Though collateral-backed loans help borrowers fulfill their personal or business requirements in different ways, it has certain limitations at the same time. Here is a list of the pros and cons of these loan options:

Examples

Let us consider the following secured loans examples to understand the concept better:

Example #1 (Conceptual)

Mary desires to buy a car. So, she contacts a bank for a car loan. The bank says that they will approve the loan on one condition. It states that the loan seeker needs to keep the car as collateral until the loan amount and the interest charges are paid off.

The lender also clears that Mary’s acceptance will mean a much lower reduced interest rate for the loan amount. So, she agrees and acquires the housing loan to buy her dream house.

Example #2 (In the Event of Default)

Roger takes a housing loan from a bank and pays off the loan in installments. However, he lost his job and started defaulting as he ran short of funds. As a result, the bank declares ownership of the house. The bank conducts property valuation and notices that the market value of a house isn’t enough to pay off the entire loan. So, the bank sells off the house and asks Roger to pay the difference.

Secured Loans vs Unsecured Loans

Secured and unsecured loans Unsecured Loans An unsecured loan is a loan extended without the need for any collateral. It is supported by a borrower’s strong creditworthiness and economic stabilityread moreare two loan options borrowers receive while looking for finance. Though both these alternatives assess the credit score and eligibility of the borrowers before approving the funds required, there are a few differences between the two that loan seekers must be aware of before choosing one of them.

As the name suggests, collateral-backed loans are secured against collateral/security. These are applied for or offered to individuals who require a large amount to make a big purchase. As the loan repayment is guaranteed, the approval is faster as no specific credentials need to be verified. The collateral backing the loan amount is enough.

On the other hand, an unsecured loan is obtained based on the credit score that the borrowers acquire. Some examples of such loans include student loans, personal loans, etc. The income proof and other financial credentials are perfectly checked along with the credit scores. The lenders approve the loan application if the score and ratings are up to the mark.

As these loans are collateral-based, the secured loan rates are lower as lenders are assured of receiving repayments even in the event of default. On the contrary, the interest rate charged is higher for unsecured finances as there is no guarantee against the lent amount.