When traditional personal loans seem out of reach due to poor credit or you're seeking the lowest possible interest rates, secured personal loans offer an alternative path to financing.
By putting up valuable assets as collateral, you can unlock better loan terms and approval odds, but with the important tradeoff of risking those assets if you can't repay.
This article will walk you through everything you need to know about secured personal loans, from how they work to whether they're right for your financial situation.
What is a Secured Personal Loan and How Does It Work?
Secured personal loans require borrowers to put up collateral, such as savings accounts, vehicles, real estate, or other valuable assets. This collateral reduces the lender's risk, making it easier for you to get approved and potentially qualify for lower interest rates compared to unsecured loans.
These loans can be used for practically any purpose, from debt consolidation to home renovations. Once approved, you'll repay the loan monthly with fixed interest rates and set payments over a specified term. However, if you default, the lender can permanently seize your collateral.
How to Apply for a Secured Personal Loan
Applying for a personal loan will generally follow these steps:
1. Determine Your Collateral
First, you'll need to decide what collateral you want to use to secure your loan. Different lenders accept different types of collateral—from cars and savings accounts to real estate and other valuables.
2. Shop Around for a Lender
Next, look for lenders that offer secured personal loans and see what types of collateral they'll accept. Compare interest rates, available loan amounts, fees, and other details. You can prequalify online with many lenders without affecting your credit score.
3. Apply for the Loan
Once you've found the right lender, submit your application for a secured personal loan. You'll need to provide information about your identity, employment, income, debts, and more. The lender will evaluate your application based on these key criteria:
- Credit score: Your credit score and credit report directly impact the loan decision and the interest rate you'll pay.
- Employment and income: The lender will review your employment and income to ensure you can repay the loan.
- Debt-to-income ratio: Lenders calculate how much of your income currently goes toward existing debts (your DTI ratio). If it's too high, it could hurt your chances of approval.
- Loan amount and loan term: The lender will consider how much you want to borrow and your preferred repayment timeline.
- Your collateral: The lender will assess your collateral's value and determine if it's suitable for lending purposes.
4. Review the Loan Offer
If your application gets approved, you'll receive a loan offer from the lender. Review the terms carefully, and if everything looks good, accept the loan to move forward.
5. Receive Your Funding
Once you've accepted the loan, the lender will disburse your funds either by paper check or direct deposit to your bank account. The timeline depends on your lender and chosen disbursement method.
"The application process for a secured personal loan will vary by loan type and lender. Secured personal loans require proof of the value and ownership history of the asset used as collateral for the loan. As part of the application process, the lender reviews your credit score and assesses the value of your collateral to decide if you qualify for the loan. Before submitting a full loan application, some lenders offer the option to prequalify, allowing you to check potential rates without affecting your credit," says Paul Ricci, CEO at online lender Best Egg.
Benefits and Risks of Secured Personal Loans
Secured personal loans have their own distinct advantages and disadvantages:
Pros of Secured Personal Loans
- Better chances of approval: Secured personal loans are easier to qualify for than unsecured loans, especially if you don't have the strongest credit score. Lenders consider you a lower risk when you put up collateral.
- Lower interest rates: You'll likely access lower interest rates with a secured personal loan compared to an unsecured loan. These lower rates can save you significant money over the loan's lifetime.
- Higher loan amounts: Some lenders offer higher loan amounts for secured personal loans than unsecured ones. Many lenders cap unsecured loans at $50,000 or less (though some go up to $100,000).
- Opportunity to build credit: If you're applying for a secured personal loan because your credit score might prevent you from getting an unsecured loan, it's a chance to build your credit with on-time payments.
Cons of Secured Personal Loans
- Collateral can be seized: Lenders can take possession of your collateral if you stop making payments and default. You could lose your assets permanently, so think carefully about what you're willing to risk.
- Lower availability: Many lenders don't offer secured personal loans, so you'll need to shop around more to find one that provides secured loans and accepts your type of collateral.
- Longer application process: The application process for secured personal loans often takes longer because lenders need to review and appraise your collateral before approval.
- Risk to your credit: If you're applying for a secured personal loan because of poor credit, consider whether you can truly afford more debt. Missing payments could damage your credit for years to come.
What Happens if You Default on a Secured Personal Loan?
When you fall 30 to 90 days behind on your secured personal loan payments, you'll likely go into default (check your loan agreement for the exact terms). Defaulting on a secured personal loan has several serious consequences:
Losing Your Collateral
"If you default on a secured personal loan, you risk losing the asset you put up for collateral and the lender can start the process of repossessing it. However, this process can take several months, and the lender might provide various options to assist you if you're facing financial difficulties," says Ricci. "If your asset is repossessed or foreclosed upon, you could still owe money if the sale of the asset doesn't fully cover the loan balance."
Late Fees
If your lender charges late fees, they'll start accumulating once your payment is past due. This increases your debt and adds to the total amount you owe your lender.
Damaged Credit
Lenders can report late payments to the credit bureaus once they're 30 days past due. Those late payments will appear on your credit report and can significantly drag down your credit score.
Missed payments stay on your credit report for up to seven years and can make it much harder to qualify for future credit or get competitive interest rates.
Accounts in Collections
Once you're behind on your loan for a certain period, the lender may move your debt to its in-house collections department or sell it to a third-party debt collector.
You'll likely receive phone calls, letters, and emails attempting to collect on your debt. Accounts in collections also appear on your credit report and further damage your credit.
Legal Action
Lenders and debt collectors can take you to court for unpaid debts. If the court rules against you, you can be legally forced to pay back the loan—and face wage garnishment, bank account garnishment, or even a lien on your home.
Tips for Getting a Secured Loan
Tip 1: Find the Right Lender
Start with your current bank or credit union, since they may offer better rates to existing customers. Online lenders often process applications faster than traditional banks, so they're worth considering if you need quick funding. Don't limit yourself to one type of institution—compare options from banks, credit unions, and online lenders to find the best fit.
Tip 2: Improve Your Chances of Approval
Get prequalified first to see potential rates and terms without affecting your credit score. Choose valuable, easily appraised collateral like cars, savings accounts, or homes rather than collectibles or jewelry.
Gather all your documentation upfront, including employment verification, income statements, and credit information, before you start applying.
Tip 3: Secure Better Terms
Shop around and compare at least three to five lenders since rates and terms can vary significantly. Consider the total cost, not just interest rates—factor in origination fees, late fees, and other charges.
Choose a loan term you can comfortably afford, keeping in mind that longer terms mean lower monthly payments but more interest paid overall.
Tip 4: Protect Yourself
Only borrow what you can afford to repay, since you could lose your collateral if you default. Read reviews and check the lender's reputation to avoid those with patterns of customer complaints.
Make sure you understand exactly when default occurs and how many missed payments could trigger collateral seizure.
"Be sure to check if you qualify for the loan before applying, and ensure that you have all of the necessary documentation (e.g., employee verification, credit information, etc.) on hand to make the process go smoothly," says Ricci.
Secured Loans vs. Unsecured Loans: Which is Right for You?
Choose a Secured Personal Loan If:
- Your credit score is below 650: Collateral makes lenders more willing to approve your application.
- You want the lowest possible interest rate: Secured loans typically offer rates 2-5 percentage points lower than unsecured loans.
- You need to borrow a large amount: Secured loans often allow higher borrowing limits, sometimes $100,000 or more.
- You're confident in your repayment ability: You must be certain you can make payments, since your collateral is at risk.
- You have valuable assets to use as collateral: Cars, savings accounts, or real estate that you're comfortable pledging.
Choose an Unsecured Personal Loan If:
- Your credit score is 670 or higher: You'll likely qualify for competitive rates without collateral.
- You don't want to risk your assets: There's no collateral to lose if you default.
- You need funds quickly: Unsecured loans typically have faster approval and funding.
- You don't have suitable collateral: Or you'd rather keep your assets unencumbered.
- You can afford slightly higher interest rates: The peace of mind may be worth paying 2-5% more in interest.
The bottom line: secured loans are ideal for borrowers with poor credit who want better terms and aren't worried about the collateral risk. Unsecured loans work best for those with good credit who value simplicity and want to keep their assets protected.
