Most people are familiar with unsecured loans in the form of credit cards, which are not guaranteed by any type of collateral. There is another common type of loan known as a secured loan. Many consumers have this type of account without even realizing it. Secured loans are often necessary to buy a large, expensive item such as a house or a vehicle. They let you finance these big ticket goods with favorable terms.
Definition
A secured loan is defined as a loan guaranteed with collateral, which is usually the item that is being financed. This item can be repossessed by the lender if the loan is not paid back. A home equity loan is one type of secured loan. The house acts as collateral, no matter how the money is spent.
Benefits
Secured loans have several benefits for borrowers, Dollar Bank says. They typically have a lower interest rate than an unsecured loan, and you can take a longer time to pay the money back. You can usually borrow money because the amount is based on the value of the collateral. A secured loan gets more favorable terms because there is less risk for the lender. Any losses would be mitigated by the sale of the repossessed collateral. You may be able to qualify for a secured loan if your credit is too marginal to open an unsecured account.
Other Examples
There are many other common types of secured loans. These include mortgages, car loans, recreational vehicle loans and boat loans, Dollar Bank says. A personal loan can also be secured if you offer a bank account as collateral. The lender would be able to take the money if you defaulted on the loan.
Effects
Secured loans have the same effect on your credit score as unsecured loans. You are still borrowing money and paying it back, so the credit bureaus can report on your balance and payment history. You will raise your credit score by making every payment on time. Your score will be harmed by late payments and especially by a repossession, which remains on your credit report for seven years.
Warning
There are other types of secured loans that do not have financial benefits. They give you quick access to cash in an emergency, but you will pay an extremely high interest rate. One common type is a car title loan, which uses your vehicle as collateral for a short-term loan. It must usually be repaid within 30 days, and the interest can average out to as much as 300 percent for a year. Cash advance companies also offer secured loans that require you to give a post-dated check as collateral. The interest rate is similar to that of a car title loan. These loans should be used with caution because of the expensive terms.
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