In general, loans fall into two categories, secured and unsecured. With a secured loan, you have to provide an asset of value as collateral. While this increases your borrowing risk, you could lose the asset if you default. You will also have more options available to you, such as better interest rates and potentially even a larger loan amount. When it comes to secured loans. The collateral will be evaluated in the same way your credit score, debt levels, and income may be evaluated.
If you’re thinking of using collateral to secure a personal loan, it is important to understand what it is and how it works.
What Is A Secured Loan?
A secured loan involves promising an asset of value as collateral for the loan. In the event that you stop making payments. Your lender can repossess the asset you put up as collateral, sell it, and then collect the money they are owed. Common examples of secured loans are mortgages and car loans.
Any loan that does not involve collateral is an unsecured loan. Common examples of unsecured loans are student loans and credit cards.
Types Of Secured Loans
In Canada, there are many types of secured loans you can apply for, such as:
- Mortgages – This loan is used to purchase a home or other real estate property. Since it’s secured against the property you’re purchasing. Your lender can legally foreclose on your home if you default. So don’t forget to make all your mortgage payments on time.
- 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.
- Secured Personal Loans – If you only need to cover essential costs. This secured loan is a lump sum of money that’s deposited directly into your bank account and repaid over time. While you can get unsecured personal loans, you can also provide collateral to help you secure them.
- Secured Credit Cards – If you have bad credit or no credit history. A secured card gives you a revolving credit limit in exchange for a security deposit of equal value. Once your term ends and all debts are paid, your deposit will be returned.
- Home Equity Loans – If you have enough equity in your home. You may be able to use it as collateral for a loan. Here, you 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. You’ll have the option of making minimum or partial payments, similar to a credit card.
20 Ways To Secure A Loan
Usually, lenders have restrictions on assets or other collateral that can be used for specific loans. For both individuals and businesses. Here are the three major types of loans, personal, vehicle, and business, as well as the most commonly used collateral for them.
Personal Loans
- Real estate (primary residence, a plot of land, secondary residence, etc.)
- Home equity (the portion of your home that your own outright becomes an asset you can use as collateral)
- Vehicles (any vehicle that it paid off, vintage, recreational etc.)
- Savings accounts (cash from a savings account is used as collateral)
- Investment accounts (eligible investments could be used as collateral)
- Valuables (items like art or jewelry are assets that can be used as collateral)
Vehicle Loans
- A vehicle you want to purchase (the vehicle you’re purchasing acts as collateral for the loan)
- A vehicle you already own (a vehicle title loan where the vehicle acts as security to
- Home equity (the portion of your home that your own outright becomes an asset you can use as collateral)
- Investment accounts (eligible investments could be used as collateral)
- Savings accounts (cash from a savings account is used as collateral)
Business Loans
- Business or personal real estate (a house, plot of land, or building owned personally or by a business)
- Home equity (the portion of your home that your own outright becomes an asset you can use as collateral)
- Machinery or equipment (equipment owned by a business that can be leveraged as collateral)
- Business or personal vehicle (car, van, truck owned personally or by business)
- Farm assets and products (specialized farming equipment and products can be used as collateral)
- Accounts receivable (business owner pledges future receivables as collateral)
- Inventory
- Business savings accounts (cash from a savings account is used as collateral)
- Debit or credit sales (referred to as a merchant cash advance).
Borrow Up To $50,000
How Does Collateral Help You Get Approved For A Secured Loan?
By providing collateral for a loan, you are making yourself a less risky candidate to the lender because they have an asset to sell as a backup if you miss payments or default. With collateral, the lender can seize the asset and sell it to recoup the money they lent to you. Without the collateral, the lender could risk losing thousands of dollars.
How Much Is Your Collateral Worth?
Often, lenders offer you less money than the value of the asset you’re using as collateral, generally between 50% and 90% of the total value. In some cases, it can actually be lower depending on the creditor and the asset type. This means that the actual value of your asset won’t be used for the purposes of your loan. In the eyes of the lender, your asset isn’t as valuable as you may think.
As an example, if you use an investment portfolio as collateral, the lender may only offer 50% of the total value to factor in the potential variability of the investment. On the other hand, lenders tend to give you up to 80% of your house value if you use your home as collateral.
Advantages Of A Secured Loan
- Better chances of getting approved. By using collateral to secure your loan, you are lowering your risk to the lender which will better your chances of approval for a loan. This is still true if your credit isn’t the greatest because you have something that is worth enough to pay back the loan in the event that you miss a payment or default.
- 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 your risk is perceived as lower by the lender.
- 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.
Disadvantages Of A Secured Loan
- Repossession. If you default on a loan, you will lose the asset being held as security. Of course, no one intends to lose the asset, but sometimes life does things to us that are out of our control.
- Too much spending. Using security for a loan usually means that you have more flexibility in how much money you can withdraw. Be sure to fully consider your financial position first before taking out debt that is unrealistic and out of your budget.
- Extended term. If you want lower payments, a longer repayment term sounds great. Although be wary, it also means you’ll be paying more interest which increases the total value of the loan.
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 for individuals that 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.
- Ample 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.
- Debt-free valuable asset(s). By owning a large asset outright, such as a home or car without debt, you’ll be able to use it as security for a loan.
- Sole proprietor. It can be challenging to prove that you have enough steady income to support a loan to a lender without security as a sole proprietor.
Additional Reading
Secured Loan FAQs
What happens if you default on a secured loan?
What credit score is needed for a secured loan?
What is an unsecured loan?
Now That You Know, Get the Loan!
Now that you know more about secured and unsecured loans, your next step is to apply for the loan you want. If you’re looking to apply for a loan, Loans Canada can help you apply for both secured and unsecured loans today.
