Secured Loans

Loans—whether they’re personal loans or business loans—can be secured or unsecured. With an unsecured loan, no collateral of any kind is required to obtain it. Instead, the lender allows you to borrow based on the strength of your credit score and financial history.

Secured loans, on the other hand, require collateral to borrow. In some cases, the collateral for a secured loan may be the asset you’re using the money to purchase. If you’re getting a mortgage for a home, for example, the loan is secured by the property you’re buying. The same would be true with a car loan.1

If you default on the loan, meaning you stop making payments, the lender can seize the collateral that was used to secure the loan. So with a mortgage loan, for instance, the lender could initiate a foreclosure proceeding. The home would be auctioned off and the proceeds used to repay what was owed on the defaulted mortgage.2

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral, and if the borrower defaults, the creditor takes possession of the asset used as collateral and may sell it to regain some or all of the amount originally loaned to the borrower. An example is the foreclosure of a home. From the creditor’s perspective, that is a category of debt in which a lender has been granted a portion of the bundle of rights to specified property. If the sale of the collateral does not raise enough money to pay off the debt, the creditor can often obtain a deficiency judgment against the borrower for the remaining amount.

The opposite of secured debt/loan is unsecured debt, which is not connected to any specific piece of property. Instead, the creditor may satisfy the debt only against the borrower, rather than the borrower’s collateral and the borrower. Generally speaking, secured debt may attract lower interest rates than unsecured debt because of the added security for the lender; however, credit risk (e.g. credit history, and ability to repay) and expected returns for the lender are also factors affecting rates.The term secured loan is used in the United Kingdom, but the United States more commonly uses secured debt.

Purpose

There are two purposes for a loan secured by debt. In the first purpose, by extending the loan through securing the debt, the creditor is relieved of most of the financial risks involved because it allows the creditor to take ownership of the property in the event that the debt is not properly repaid. In exchange, this permits the second purpose where the debtors may receive loans on more favorable terms than that available for unsecured debt, or to be extended credit under circumstances when credit under terms of unsecured debt would not be extended at all. The creditor may offer a loan with attractive interest rates and repayment periods for the secured debt.

Types

  • A mortgage loan is a secured loan in which the collateral is property, such as a home.
  • A nonrecourse loan is a secured loan where the collateral is the only security or claim the creditor has against the borrower, and the creditor has no further recourse against the borrower for any deficiency remaining after foreclosure against the property.
  • A foreclosure is a legal process in which mortgaged property is sold to pay the debt of the defaulting borrower.
  • A repossession is a process in which property, such as a car, is taken back by the creditor when the borrower does not make payments due on the property. Depending on the jurisdiction, it may or may not require a court order.