If you want to borrow money with lower interest rates, you should go for secured debt. Lenders consider this type of loan to be less risky; thus, they tend to offer favorable terms.
This free resource will help you to understand the following about secured loans.
- What is a secured debt?
- How does it work?
- Examples of secured debt.
- Four assets you can use against a secured loan.
- Advantages and Disadvantages of secured debts.
- Where to apply for secured loans?
What is secured debt?
A secured debt is any loan you take against an asset(things you own) that serves as collateral. The amount you borrow becomes a secured debt which you owe to the lender. Failure to clear or settle this debt will result in losing your asset to the lender. This lender then sells the property to regain the amount you borrow.
If you are the borrower, only go for an amount you know you can repay in the given repayment schedule. It is never a good feeling to lose your asset to the lender because you couldn’t repay your debt. Remember, the amount you got from the loan is less than the value of your property.
Now that you clearly understand the meaning of secured debts, let’s see how they work.
How does Secured debt work?
Let’s say you’re short of cash and need money to purchase a house, a car, or fund a business transaction. For the sake of simplicity, let’s use the house example.
You can approach your bank or a lender and ask them to finance the purchase of this new house. In this example of purchasing a home, you might be required to make a deposit payment of around 20% of the total value. Some lenders or banks can finance the purchase of the house in full without any deposit.
Although the purchase is made in your name, the bank/lender will place a Lien on the property. This Lien gives the bank or lender the right to repossess your house if you can no longer cope with the repayments. If you can’t commit to the repayment schedule, the bank will sell the house to recover the loan amount.
Besides the above explanation of secured debt example, there are other types of secured debt. Let’s see that in the section below.
Examples of secured Debt
In general, there are two major types of secured debt; mortgages and title loans. The item being financed acts as the collateral. Again, if you fail to pay off your debt, the lender takes ownership of your property.
Title loans can be on properties like cars, boats, motorcycles, or trailers. You can finance or refinance title loans with a secured loan. You can also take up a personal loan and submit your property as collateral.
4 Assets you can use against a secured loan.
As you know by now, to have secured debt, you need a valuable asset to act as collateral against the amount you need. Below is the list of assets you could use for a secured loan.
You can quickly get a low-interest secured loan as a home or real estate owner by using your home, building, or apartment as collateral. Although the amount available to you is usually large, it is no more than 70% of your home’s current value. The LVR (Loan-to-Value Ratio) ranges from 50% to 70%.
Let’s assume you have a home already and you want to finance a second home purchase. You can use your first home as collateral and secure a loan amount of no more than 70% of your home’s current value. This scenario only makes sense if your second home is at least 30% cheaper than the first home you put as collateral.
The situation is a bit different with a first-time home purchase. If the house you want to buy is your first, you can still use it as collateral to secure a loan. But you have to pay at least a 20% downpayment deposit of the home’s current value.
You pay this 20% downpayment deposit to the lender who is financing the purchase of this property. The lender then buys the property from the current owner. When you complete the remaining 80% plus interest payment to the lender, you become the sole owner of the property.
If you own an automobile, you can use it as collateral on a secured loan. The most common automobiles used are cars, boats, trailers, and trucks. You can either finance the purchase of such automobiles or use it as collateral for a personal loan.
Another scenario is auto-refinance. You take up an auto refinance loan with auto-refinancing to pay the balance you owe on the first auto-finance loan. In other words, you take a second loan to pay off the first debt.
Last but not least, the title loan is costly in terms of interest rates. You can take up a car title loan and use the original documents of the car as collateral. The lender places a LIEN on the vehicle, which gives them the right to repossess your vehicle if you fail to repay the loan.
3. Certificate of Deposit:
If you have money in your savings account and you don’t want to touch it, you can borrow money against the savings. In real life, this doesn’t make any sense because you will be paying unnecessary interest. Unless you have a long-term saving investment in which you have to pay charges for early withdrawal, don’t use this option.
4. Other Valuables:
Depending on the amount you need, you can use other valuables you own to get a small loan. These valuables include jewelry, precious metals, electronics, antiques, smartphones, power tools, etc. Although this is a secured loan, the interest rate is relatively high.
Advantages and Disadvantages of secured debts
Like always, borrowing comes with a greater risk if there is collateral involved. Although secured debt is risky if you are the borrower, there are some benefits of secured loans. Let’s take a look at the advantages of secured debt.
You get a much lower interest rate:
Since you provide collateral against the loan, you get a much lower interest rate. The interest rates of secured loans are the lowest because your lender can quickly recover the amount you owe. Lenders consider secured loans to be less risky. So the less risky the loan, the lower the interest rate.
Although the interest rate is much lower than unsecured loans, some secured debt has ridiculously high-interest rates. An example of this type of secured loan is the car title loan.
Larger Loan amount available:
The available amount on secured loans is usually significant. Depending on the value of your collateral, you can even borrow up to $2 million. Apart from financing a property purchase, the available loan amount is usually 60% of your collateral value.
So if your collateral is worth $500K, you can only get around $300K for a secured loan. This way, the lender can minimize the risk in case the market value of your collateral drops.
Secured debt builds your credit:
Paying off your secured debt comes with great relief. In addition to that satisfactory feeling, your credit score will increase. Your lender is obliged to inform the credit bureau of your repayment completion.
You will get a much lower interest rate on your next loan since your credit score has improved.
You get Better Loan Term:
Secured loans often come with a more extended repayment period unsecured loans. With a repayment period of over ten years, you can structurally position yourself for repayment success. Terms on home loans can extend to 30 years.
You could lose your asset:
The most damaging aspect of a secured loan is that you could lose your asset if you fail to repay the loan. Depending on the terms and conditions of the loan agreement, the lender can fully repossess your property.
If the lender can’t recover the amount you owe from selling your property, you will have to pay the balance. Not only could you lose your asset, but you could also still be drawn in debt.
A trap of borrowing more than you need:
Since you have the possibility of getting a substantial, you might be tempted to borrow more than what you need. Borrowing more than what you need could easily lead to unnecessary spending, which can negatively affect your financial stability.
Own a more valuable asset than the amount you need:
You can’t take a secured loan without being the owner or co-owner of a valuable asset. Your property must be more valuable than the amount you need for the loan.
Where to apply for secured loans
Although countless lenders are offering secured loans, most of them are shady. You can either use your bank or a credit union to get a secure loan.
Despite the numerous shady lenders out there, some good ones have more favorable secured loan terms.
Be careful when getting yourself in a secured debt because some are costly and risky if you’re the borrower. Always compare offers to get the best rates and terms.