Lending money is big business. A bank charges you interest on the amount you borrow, but sometimes the bank wants additional assurance that you will pay off the loan. Most loans are secured loans, meaning there is an item of value attached to the terms of the loan and if you fail to make your payments, you may have to forfeit this item to the bank or financing company. Some distinct benefits and risks come with secured loans.
Function
The secured loan serves two purposes. It provides a benefit to the borrower, who uses the funds to buy a home or car or for another purpose. Meanwhile, the bank makes money by charging the customer interest.
Items
An item of provable value can serve as collateral for a loan. In real estate, the home itself serves as the security for a mortgage loan. When taking out a loan to buy a car, the lender will establish a lien against the vehicle until you repay the entire loan. Other items that may secure a loan include, but are not limited to, investments, certificates of deposit, businesses, jewelry or equipment.
Benefits
A secured loan can help a borrower establish credit or improve less-than-stellar credit. For many, taking out a home mortgage is the only way they can afford to buy a home. Businesses regularly take secured loans for purchasing equipment or buildings. Without the ability to borrow the money, many could not purchase these items.
Cash Advance
Secured loans obtained through "quick cash" stores come with high interest rates and additional fees, making it difficult for the borrower to repay the debt. These businesses may offer a loan secured by the borrower's paycheck or the title to his car. Consumers should avoid these loans if possible.
Risks
Using an item you own to secure a loan always comes with some risk. If you fall behind on your mortgage, the bank will foreclose on your home. If you don't pay your car note, the lender may repossess your vehicle. Secured loans are less risky for banks, but they are more risky for borrowers, who stand to lose their property.
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