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Secured loans can help borrowers access much-needed cash or make large purchases—like a home or new car. The loan is secured by the pledging of the asset as security, which means the item will be repossessed if the borrower defaults.
By pledging the valuable asset, a borrower is considered less risky and can usually obtain a much more competitive interest rate than on an unsecured loan.
This guide explores how secured loans work, the pros and cons, and how to obtain one.
Related: Our Pick Of the Best Personal Loans for Australians
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What Is a Secured Loan?
A secured loan is one that is collateralised—or secured—by a valuable asset, such as real estate, cash accounts or most commonly in Australia: your car. In many cases, the loan is secured by the underlying asset being financed like a home or vehicle. Alternatively, borrowers may be able to pledge other collateral like investments or valuable collectibles.
If a borrower defaults on a secured loan, the lender can repossess, foreclose on or otherwise seize the asset to recoup the outstanding balance. For this reason, secured loans pose less risk to lenders and, therefore, often come with lower interest rates and borrower requirements than unsecured loans.
Secured vs Unsecured Loans
For example, in the case of secured vs unsecured personal loans, a borrower with a high credit score may qualify for an unsecured loan with a low interest rate without having to pledge any collateral. Another applicant for the same unsecured loan might not qualify and have to rely on a secured option because they present more risk.
One type of loan isn’t necessarily better than the other, but it’s important to understand your options before signing on the dotted line.
How Secured Loans Work
Secured loans let borrowers access a lump sum of cash, which can be used to cover everything from home renovation projects to the purchase of a car or home. You can typically obtain these loans from traditional banks, credit unions, online lenders, auto dealerships and specialised finance lenders.
Even though secured loans are less risky for lenders, the application process generally requires a credit check—though some lenders offer the ability to prequalify with just a soft credit inquiry. And, while secured loan balances accrue interest like other loans, borrowers may access lower interest rates than are available with unsecured options.
Once a borrower qualifies for a secured loan, the lender places a ‘lien’ on the borrower’s collateral. This gives the lender the right to seize the collateral if the borrower defaults on the loan. The value of the collateral should be greater than or equal to the outstanding loan balance to improve the lender’s chances of recovering its funds.
What Can Be Used as Collateral on a Secured Loan?
Often the type of collateral required for a secured loan is related to the purpose of the loan. This is most commonly illustrated in the case of mortgages, where the home loan is collateralised by the house being financed. That said, the type of collateral can also depend on a number of other factors, including the lender and the loan amount.
Common forms of collateral include:
- Real estate, including homes, commercial buildings, land and equity in real estate
- Bank accounts, including savings accounts
- Investments like stocks, managed funds and bonds
- Insurance policies, such as life insurance
- Vehicles ranging from cars, trucks and SUVs to motorcycles and boats
- Other valuable assets like precious metals, coins and collectibles
- Machinery, equipment, inventory and other business assets
What Happens If You Default on a Secured Loan?
If you default on a secured loan, your lender can seize the collateral to recoup the outstanding balance on the loan. In the case of a mortgage, this involves filing a foreclosure action against the borrower. If you default on a car loan, the lender can repossess the financed vehicle. In general, the value of the underlying loan collateral should meet or exceed the loan amount—this improves the lender’s chances of limiting their losses in the case of default.
However, there are certain circumstances under which the loan balance can exceed the value of the collateral.
For example, if you buy a home at the peak of the real estate market and then default on your mortgage during an economic downturn, the bank may not be able to recoup the mortgage amount through a foreclosure sale. Where the sale of the collateral doesn’t cover the full outstanding balance of a loan, the lender can attempt to recover the remaining amount by filing for a deficiency judgment.
If you have a secured loan and think you may default, there are steps you can take to limit negative impacts on your credit score. Contact your lender immediately, review your budget and prioritise secured loan payments so you don’t lose your house or other valuable assets.
Types of Secured Loans
Mortgages and car loans are perhaps the most well-known secured loans, but there are a number of other purchases that may require collateral. These are the most common types of secured loans:
- Mortgages: Mortgages, or home loans, are a common type of loan used to finance the purchase of a home or other real estate. These loans are secured by the financed property, meaning the lender can foreclose in the case of borrower default.
- Home equity lines of credit: A home equity line of credit (HELOC) is a revolving loan that is secured by the borrower’s equity in their home. The borrower can use the funds on an as-needed basis.
- Home equity loans: Like a HELOC, a home equity loan is collateralised by the borrower’s home equity. With a home equity loan, however, the borrower receives a lump sum of cash, on which interest begins accruing immediately.
- Car loans: Car loans are secured by the vehicle being financed. To protect its interest in the collateral, a lender holds title to the financed vehicle until the loan is repaid in full.
- Secured personal loans: Secured personal loans let borrowers access cash that can be used for personal expenses like home improvements, holiday costs and weddings.
How To Get a Secured Loan
Secured loans are typically available through traditional banks and credit unions, as well as online lenders, car dealerships and mortgage lenders.
Follow these five steps to get a secured loan:
- Check your credit score: Before applying for any loan, check your credit score using a free online service or your credit card provider. Once you familiarise yourself with your score, use the information to prequalify for a loan, or take steps to improve your score—and your approval chances.
- Review your budget: If you’re considering a secured loan, it’s also helpful to review your budget to determine what you can afford to pay each month. It’s always important to consider existing debt payments when taking on a new loan.
- Evaluate the value of collateral: When you’re ready to shop for a loan, evaluate the value of your potential collateral—including cash account balances, home equity and any other valuable possessions—to see how much you can borrow. It’s worth noting, however, that banks won’t go one-to-one of an asset’s value; putting forward a $50,000 asset won’t result in a $50,000 loan.
- Shop around for the best loan. After evaluating your credit score and how much money you can afford to borrow, start researching lenders. If you’re considering a HELOC or home equity loan, contact your current lender to learn more about your options.
- Submit a formal application. Unlike the application process for an unsecured loan, lenders that offer secured loans will likely require an appraisal to confirm the value of your collateral before extending the loan. Sometimes these applications can be completed online.
Pros Of Secured Loans
- You may be able to access lower interest rates with a secured loan than with an unsecured alternative.
- It may be easier to qualify because secured loans pose less risk to lenders.
- Borrowers can take advantage of tax deductions for interest payments on some secured loans, such as mortgages.
Cons of Secured Loans
- If you default on the loan, your collateral could be repossessed or foreclosed on.
- Borrowing is less flexible because what you can use the loan for is often tied to the collateral itself.
Featured Partners
1
OurMoneyMarket
Interest Rates:
From 6.57% p.a. / Comparison Rate 7.19% p.a.
Loan amount
$2,001 to $75,000.
Fees
Establishment fee from $250
2
Harmoney
Simple, 100% online.
Rates from 5.76%² to 24.03% (comparison rate 6.55%)
Start almost anything.
Borrow $2K- $70,000. Won’t affect your credit score
No monthly account keeping or early repayment fees
FAQs
What is a secured loan?
A secured loan is one in which the amount you are borrowing is secured against an asset, such as your car or home. This means that if you fail to make your repayments this asset which has been put up as collateral will be seized.
What is the difference between a secured and unsecured loan?
A secured loan is backed up by an asset—usually your car or home—in case you can no longer make repayments and the lender will then acquire your asset. On the contrary, an unsecured loan is much riskier for the lender as no collateral is put up, so the interest rate on these loans is usually higher.
What is better: an unsecured or a secured loan?
This depends on your financial circumstances, as well as your ability to pay off your loan in full, but generally speaking secured loans have lower interest rates (as they’re less risky for the lender) so are cheaper for consumers in the long-run.
What are the interest rates on a secured loan?
As of July, 2024, the best secured interest rate starts at around 6.5%.�� Note that these interest rates are only available to those with excellent credit—if you have a poor credit score, you could be paying interest as high as 20%.
