What is a secured loan? Learn the risks and advantages

What is a secured loan? You might be wondering if you’re improving your home or need to make a large purchase. Keep reading to learn more about secured loans.
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A secured loan is a type of financing that uses an asset as collateral. Your home is the most common type of collateral used for secured loans. Other smaller loans might be secured against your car or other valuables, but these tend to be more risky.

Some examples of secured loans include:

Secure loans are unique, and have distinct benefits and drawbacks. To learn about secure loans and the risks and benefits involved with them, keep reading!

What’s the difference between secured and unsecured loans?

The main difference between secured and unsecured loans is collateral, which is what makes a loan secure for a bank. In fact, that’s what ‘secured’ and ‘unsecured’ refer to — the level of risk facing a bank or lender. That risk is low with a secured loan because even if you default on your payment, the bank can collect the collateral.

Unsecured loans are risky for banks or lenders in contrast to secured loans. Rather than collateral, unsecured loans are approved based on factors like an impeccable credit score or payment history.

What are the benefits and drawbacks of secured loans?

Secured loans are less risky for banks and lenders. That changes a lot of things about how these loans work for you, which is both a benefit and a risk. Let’s take a closer look at the benefits and drawbacks of secured loans here.

Benefits of secured loans

Secured loans can be a good choice depending on your needs. Some of their key benefits include the following:

Secured loans are easier to get:

To get an unsecured loan, you need a strong credit score and repayment history. That’s because lenders need to be confident they’re not going to lose money by lending to you. But with a secured loan, your collateral acts as insurance for the lender. This makes your credit score and payment history less important.

Now, that’s not to say that your credit score doesn’t matter for a secured loan. It does. But, it plays a less significant role in determining your eligibility. Because of this, secured loans are generally easier to get if you have less-than-perfect credit.

Related read: I need a loan but keep getting declined: All about refused credit

You can borrow larger amounts with secured loans

When banks are lending you money, the amount you are eligible for comes down to risk. A bank or lender will only give you as much as they can confidently expect you to pay back. So, unsecured loans are limited in value by things like your income that illustrate your ability to repay.

But this changes with secured loans. The lender can give you more money because your collateral will cover it if you don’t pay.

A secured loan’s longer payment terms enable lower payments

Personal loans usually have terms between one and five years, or seven years at most. This means that for larger loan amounts, you don’t have any choice but to make larger monthly payments. Secured loans can be stretched out much longer than that, allowing you to reduce your monthly payment.

Drawbacks of secured loans

Secured loans aren’t without risk. Before you get a secured loan, make sure you understand the following drawbacks.

You could lose your collateral

If you default on a secured loan, the lender can collect the collateral that the loan was secured against. In most cases, that’s your home. This makes secured loans a risky option if you have any doubt about being able to make your monthly payments.

Variable interest rates can cause your monthly payments to change

Most secured loans have a variable interest rate, meaning the interest rate you pay will shift with Bank of England base rates. While it’s possible to benefit from lowered interest rates, you’re also exposed to the risk of rising interest rates.

If your budget is tight each month, an increase in your monthly payment could cause you to miss payments. If you get a secured loan with a variable interest rate, leave yourself lots of wiggle room when it comes to your budget for monthly payments.

Related read: What is the Bank of England base rate and how does it impact me?

Longer payment terms lead to higher overall costs

Low monthly payments are a distinct benefit of secured loans. But they come at a price. While your monthly payment burden goes down, your long-term payment burden increases. This is because your lender will be charging interest on the loan for a longer period.

It’s a tradeoff you might be willing to make: pay less each month, but more in the long term. Regardless of what you choose, it will impact your finances. So, it’s essential to consider each aspect of secured loans before committing to one.

Tips for building your credit to get a loan

If you’re not comfortable with the risks of a secured loan, you’ll need another type of financing. But if you don’t have great credit, you might not qualify for other options. If you want to build your credit, try some of these strategies:

Use a credit builder loan

A credit builder loan is somewhat similar to a loan itself. Here’s how it works: when you’re approved, a bank, building society, or lender puts a sum of money into an account. Then, you make payments on that sum as you would for a loan.

The main difference between a personal loan and a credit builder loan is that with the latter, the money isn’t released to you until you’ve finished paying it off. The bank will report your payments to credit reference agencies, which helps build your credit score.

Get a credit builder card

A credit builder card has a low credit limit and a relatively-high interest rate. The purpose of a credit builder card is to prove your ability to make timely payments. This is vital, as your payment history is one of the most important factors impacting your credit score.

Eventually, you may be able to increase your credit limit or get a new card if you’ve built a consistent payment history.

Build your credit with the Pave App

The Pave app can help protect your payment history and teach you what actually impacts your credit score. Plus, we may be able to lend you interest-free money, and paying that back on time can boost your credit score.

If you’re ready to see for yourself why hundreds of thousands of Brits have turned to Pave, check the app out on Google Play or the App Store today! 

FAQs about secured loans

Have more questions about secured loans? We’ve got answers.

Can you get a secured loan with bad credit?

Your credit score still plays a role in your ability to get a secured loan. However, it’s not as significant because your collateral protects the lender. Keep in mind that if poor financial habits have led to a low credit score, a secured loan might not be a wise choice.

Remember if you default on a secured loan, you could lose your collateral, whether that’s your home, car, or another valuable asset.

Can you repay a secured loan early?

Yes, you can repay a secured loan early. Some lenders or banks will require you to pay a few months’ interest payments to make up for early repayment. Reading your loan agreement carefully to understand the early payment conditions is always a wise choice.

Should I take out a secured loan against my car?

Loans that are secured against your car are often called logbook loans because you have to give the lender your car’s logbook or registration. While logbook loans do carry some of the same benefits as regular secured loans, they tend to be risky for one big reason: high interest.

According to the FCA, logbook loans tend to have interest rates as high as 400%. That means you’ll end up paying back much more than you borrowed. If you can’t afford those payments, you could lose your car. For that reason, you’ll be better off avoiding logbook loans.

Want to learn more about building your credit? Check out the resources in our credit library