Are you looking for an affordable and accessible way to borrow money? Secured loans may be the way to go. Since they’re backed by collateral, secured loans can be easier to qualify for and tend to come with lower rates compared to unsecured financing. But what kind of collateral can you use? Let’s explore smart ways to secure a loan.
Key Points
- A secured loan is a type of financing that requires collateral to back the loan.
- Secured loans can make it easier to get approved for financing at a lower rate.
- Some of the more common assets used to collateralize secured loans include real estate, vehicles, and equipment, though security can take many forms.
What Is Loan Security?
Loan security involves using a valuable asset to collateralize a loan, which reduces the lender’s risk in the event the borrower defaults. In this case, the lender can repossess the asset and sell it to recoup their funds.
| What Is A Secured Loan? A secured loan involves using an asset of value as collateral for the loan. In the event that you stop making payments, your lender can repossess the asset, sell it, and use the proceeds to cover what they’re owed. This reduces the lender’s risk, making them more willing to approve your loan application and offer you a lower rate in exchange. |
Types of Collateral You Can Use To Secure A Loan
You can secure a loan using various valuable assets, including the following:
Tangible Assets
A tangible asset is a physical item with measurable value that can be seen and touched. It’s easier to liquidate a tangible asset and sell it compared to an intangible asset.
| Examples of tangible assets: – Personal real estate: Primary residence, a plot of land, secondary residence, etc. – Home equity: The portion of your home that you own outright. – Vehicles: Any vehicle that it paid off, vintage, recreational, etc. – Savings accounts: Cash from a savings account. – Valuables: Art, electronics, or jewelry, etc. – Machinery or equipment: Tools, vehicles, and other equipment used for business purposes or personal use. – Parking spaces: Busy, high-demand areas may command strong interest in parking spots. – Timeshares: Ownership of a fraction of a property. – Collections: Rare coins, stamps, etc. |
Intangible Assets
An intangible asset is a non-physical resource with value. Lenders typically accept intangible collateral only when it’s backed by tangible assets or when the borrower has excellent credit.
| Examples of intangible assets: – Patents: A legal right for exclusive control over the use, production, and sale of an invention for a set period. – Trademarks: A symbol, word, or phrase legally registered to represent a company or product. – Copyrights: Protect original works of authorship. – Contracts: A legally binding agreement outlining specific obligations and terms. – Insurance policies: Plans with cash value may be used as collateral. – Trust funds: Assets managed by a trustee. |
Borrow Up To $50,000
Loan Security: Types of Loans You Can Secure With Collateral
There are many types of loans that are secured by collateral. Here are some secured loans you can apply for:
Secured Personal Loans
Personal loans may be secured with an asset to increase your odds of loan approval at a competitive rate. You’ll receive a lump sum of money that can be used for a variety of purposes.
With a personal loan, you can typically use any tangible or intangible asset as collateral. However, the types of collateral accepted will vary by lender and asset value.
Life Insurance Policy Backed Loan
A life insurance policy-backed loan is a type of financing where the borrower uses the cash surrender value of a life insurance policy — typically a permanent policy like whole life or universal life — as collateral to secure financing.
In other words, the collateral is the life insurance policy itself, specifically its cash value and death benefit. In the event the borrower defaults, the lender can claim cash value and death benefit.
Secured Line Of Credit
A secured line of credit is a type of revolving loan that allows borrowers to access funds as needed. It’s backed by collateral, which can include both tangible and intangible assets, depending on the lender’s policies and the asset’s value.
When home equity is used as collateral for a secured line of credit, it essentially becomes a Home Equity Line of Credit (HELOC), which is a distinct financial product with its own terms..
Investment-Backed Loans
An investment-backed loan allows borrowers to use their existing cash and investment portfolio as collateral. This allows borrowers to have access to their funds without having to liquidate assets.
You can typically borrow up to a certain percentage of the asset’s market value, which varies based on the type of investment and its associated risk.
Business Loans
A business loan provides funding to help start or grow a business. Business loans can involve term financing, where a lump sum is provided and repaid over time with interest, or a business line of credit, which involves flexible access to funds up to a set limit and repaid as you borrow.
Business loans can be secured or unsecured. If opting for a secured business loan, various types of business assets may be used as collateral, such as:
- Business or personal real estate: A house, plot of land, or building owned personally or by a business.
- Machinery or equipment: Equipment owned by a business.
- Business or personal vehicle: A car, van, truck owned personally or by business.
- Farm assets and products: Specialized farming equipment and products.
- Accounts receivable: Business owner pledges future receivables as collateral.
- Business savings accounts: Cash from a savings account.
- Debit or credit sales: Future receivables may be used as collateral.
- Accounts receivable: Future receivables may be pledged as collateral.
Learn more: Secured Business Loans
Mortgages
A mortgage is used to purchase real estate and is secured against the property you’re purchasing. The lender can seize the home if you default on your loan payments.
A mortgage is always secured by the property itself. In other words, you can’t use any other type of asset to collateralize a mortgage, as this type of loan is used specifically to finance a home.
Car Loans
An auto loan helps you finance a car over time. Similar to a mortgage, the lender will hold onto the vehicle’s title until your loan is paid in full. They can repossess it if you miss too many payments.
Like mortgages, car loans are used for the purpose of financing a specific asset. In this case, a car loan is used to buy a vehicle. As such, only the vehicle being purchased may be used to collateralize the loan.
Secured Credit Cards
If you have bad credit or no credit history, a secured card gives you access to credit in exchange for a security deposit. Once your term ends and all debts are paid, your deposit will be returned. Every timely payment is reported to the credit bureaus, helping you build good credit over time.
Second Mortgages
If you have enough equity in your home, you may be able to use it as collateral for a loan. You can use the equity in your home to secure two types of secured loans:
- Home Equity Loans: You’ll get a lump sum of cash, which starts to generate interest right away, and the lender can seize the equity if you default.
- Home Equity Lines of Credit: A HELOC is also secured against your equity. It gives you a revolving credit limit that you can withdraw from as you need.
Learn more: Loans With Collateral
Things To Remember When Using Loan Security
Before applying for a secured loan, it’s important to consider the following:
The Asset Value Matters
The value of your collateral depends on its current market value and how much a lender is willing to lend against it. Lenders usually evaluate the market value of your collateral before approving a loan. If the asset isn’t worth enough, they may either reject your application or approve a smaller loan amount.
The value of the asset is typically calculated using the following factors:
- Fair Market Value: What your asset would sell for in an open market.
- Discount Rate: Lenders often apply a discount to account for risk and liquidation costs.
- Loan-to-Value (LTV) Ratio: This determines how much of the value can be borrowed.
| Example: Let’s say your home is worth $500,000 and the lender offers an 80% LTV. The collateral would be calculated as follows: Collateral Value = $500,000 × 80% = $400,000 In this case, the maximum loan amount you may qualify for using your home as collateral is $400,000. |
Your Asset Can Lose Value During The Loan Term
What happens if the asset you pledge loses value, particularly if its value falls below the outstanding loan amount? In this situation, the following may occur, depending on the loan type:
- Mortgages can go underwater: When a mortgage goes underwater, it means the outstanding loan balance is higher than the current market value of the home. In this situation, you’ll owe more than the home is worth, making it difficult to sell or refinance.
- Car loans may go “upside down”: When a car loan goes upside down, it means you owe more on the loan than the car’s current market value. This can happen due to low down payments or rapid depreciation, making it risky to sell or trade in the vehicle without having to cover the difference.
- Investment-backed loans may require you to pledge other securities: If the value of the securities used to secure the loan falls below a certain amount, the lender may require you to either repay part of the loan or line of credit, or offer up additional securities.
Loan Security: Why It’s A Smart Borrowing Strategy
While adding collateral to your loan can add risk, it can also be a good strategy when trying to secure a loan. It can lead to:
- Better chances of getting approved. By using collateral to secure your loan, you’re lowering the lender’s risk, which will improve your chances of loan approval. This is especially helpful if you have bad credit.
- Lower interest rates. Generally, secured loans have more competitive interest rates than unsecured loans. Even if you have poor credit, you can still secure a lower interest rate by using collateral because of the lender’s perceived lower risk.
- Ability to negotiate. If you use collateral for your loan, it gives you more room to negotiate terms that work best for your budget. You can negotiate to lengthen the loan’s term to get smaller monthly repayments or shorten the loan term to make the whole loan cheaper, whichever would benefit you the most.
Why Loan Security Isn’t Always a Good Idea
Consider the following potential drawbacks before offering an asset for added security:
- Risk of repossession. If you default on a loan, you risk losing the asset. The lender may choose to seize the asset and sell it to recoup their losses.
- Temptation to borrow too much. Using security for a loan often comes with a higher loan amount offered. Be careful not to borrow more than you need.
- Lien on property: The lender places a lien on your asset, which can complicate future sales or refinancing, depending on the exact loan type.
Secured Vs Unsecured Loans
Secured loans differ in key ways from unsecured loans:
| Secured Loans | Unsecured Loans | |
| Collateral Required | Yes | No |
| Risk to Borrower | Asset seizure if you default | Damage to credit score |
| Interest Rates | Typically lower | Typically higher |
| Loan Amounts | Higher borrowing limits | Lower borrowing limits |
| Credit Score Requirements | Easier with bad credit | Requires good credit |
| Loan Types | – Mortgages – Car loans – Home equity loans | – Personal loans – Credit cards – Student loans |
Learn more: Unsecured vs. Secured Loan: What’s The Difference?
Should You Choose A Secured Loan Or An Unsecured Loan?
As with most things, what works for you might not be ideal for someone else. To determine if a secured loan or unsecured loan is better, you will have to consider and analyze your financial position.
Secured loans are ideal in the following situations:
- You have poor credit. It will be challenging for you to get approved for a loan if you have poor credit, but offering security will improve your chances.
- You have lots of existing debt. The more existing debt you have, the higher your debt-to-income ratio will be, which makes it challenging to qualify for unsecured lending. Securing your loan can reduce the hurdles to getting loan approval.
- You own debt-free valuable asset(s). By owning a large asset outright, such as a home or car without debt, you may be able to use it as security for a loan.
- You’re self-employed. It can be challenging to prove that you have enough steady income to support a loan to a lender without security when you’re self-employed. Collateralizing your loan can reduce the lender’s risk and boost your odds of loan approval.
Final Thoughts
There are various ways to secure a loan, including using your home, car, investments, and equipment. By using collateral, you can improve your odds of loan approval, even if you have bad credit.
