A personal loan is one of the most often chosen options for solving various financial problems. People borrow money from personal loan lenders to cover unexpected expenses, improve their homes, repair their cars, and pay for other costs. Most loans from personal loan providers are unsecured. You don’t need to provide a lender with collateral, which you can lose if you fail to repay the debt.
However, getting an unsecured loan is often challenging with bad or poor credit history. Therefore, many people apply for a secured loan to build credit and borrow extra cash for a longer term with a lower interest rate. Keep reading to explore the requirements for a secured loan, how it works, and whether it helps you improve your credit score.
What Is a Secured Personal Loan and How Does It Work?
A secured personal loan is a loan backed by collateral, an asset that belongs to the borrower. A vehicle, property, or a savings account are the most common collateral applicants provide. These valuable items serve as a guarantee for a lender that you will repay the loan.
If a lender approves your application, it will send you a loan agreement. Read it carefully to understand all the loan terms and conditions. Then, sign the contract if you agree with all its details. After you sign the agreement, a loan provider will deposit the required loan amount directly to your checking account. You will need to return the funds with interest rates within a set repayment term. As long as you make on-time payments for your secured loan, you keep the collateral. If you miss your monthly payment, a lender can seize your asset to sell it and recover the loan amount you have borrowed.
Secured Loans Vs. Unsecured Loans?
It is crucial to understand the difference between secured and unsecured loans when applying for financial assistance. The two options allow borrowers to borrow extra money for their needs but with different conditions.
The most essential thing when comparing a secured loan vs. an unsecured loan is that the first option requires collateral from a borrower. Your valuable item makes lending money safer for a lender. It will not lose its money if you don’t repay the debt. In such a situation, a loan provider can seize your collateral and get back the loan amount by selling the item. Therefore, secured loans generally have longer loan terms and higher loan amounts and offer lower interest rates and eligibility requirements to borrowers.
In the case of unsecured loans, it is more problematic for a lender to get the money back if you fail to repay it. It can’t seize any of your items and can only take you to court. If a lender sues you and wins, it may be allowed by a court to seize your bank account, wages, or other assets.
Secured Loan
- Collateral is required;
- A lender can seize and sell collateral if you fail to repay the debt;
- Lower interest rates and fees;
- Longer repayment terms;
- More flexible eligibility requirements.
Unsecured Loan
- No collateral is required;
- Lenders can’t seize borrower’s valuable items if they fail to repay the debt;
- Higher interest rates and fees;
- A repayment term is generally shorter;
- Stricter eligibility criteria.
Although it is generally more difficult to obtain unsecured loans compared to secured options, you can still apply for payday loans with guaranteed approval from a direct lender. They don’t require collateral and hard credit checks and allow borrowers to receive the necessary amount within one business day. It is an excellent option for people with low credit scores who don’t qualify for traditional loans and don’t want to provide collateral to a secured loan provider.
Does a Secured Loan Build Credit?
Making on-time monthly payments is an excellent way to build your credit score. Payment history is the most important factor affecting your creditworthiness, which accounts for 35% of your FICO score. A positive payment history will stay on your credit report for ten years after you repay a secured loan.
At the same time, secured loans can negatively impact your credit score. Every late monthly payment remains on borrowers’ credit reports for seven years. It is crucial you can return your debt within set repayment terms before borrowing to avoid hurting your credit score.
If you need to improve your credit score, you can apply for a so-called credit-builder loan. It differs from traditional secured loans, as it is deposited to a borrower’s savings account, which the lender controls. Then, they need to return the money through fixed monthly payments. All these payments are reported to three main credit bureaus (Experian, Equifax, and TransUnion). Your on-time payments improve your credit score and help you qualify for loans on more favorable terms in the future.
Advantages of Secured Loans
Borrowing a secured loan is an excellent way to consolidate debt or finance your expenses. Below, you can see the reasons why you should choose a secured loan among all the loan options.
Larger loan amounts. Secured loans come with less financial risk for lenders, so they can provide borrowers with more significant amounts to a checking account.
Lower APR (annual percentage rate) and fees. Providing a lender with collateral helps borrowers get a loan without overpaying for APR, origination fees, prepayment penalties, and other charges.
Longer loan terms. Secured loans allow people to make repayment more convenient and manageable.
Easier getting money. It is easier to get approved for secured loans than for unsecured ones.
Disadvantages of Secured Loans
In addition to many benefits, secured loans have several drawbacks:
Losing collateral. You should be sure you have sufficient income to repay funds to the lender before borrowing it. Otherwise, you can lose your valuable asset.
Longer approval. You may wait longer for a secured loan, as a lender needs time to consider the value of your collateral.
Types of Secured Loans
Many lenders offer different types of secured loans. Explore all the existing options and choose the most suitable secured loan option for your needs.
- Mortgages. A mortgage is a loan used to purchase a property where the house you buy serves as collateral. It means that your loan provider can seize your home if you don’t repay the money within a set period. The loan term for mortgages can reach 30 years.
- Home equity loans. This type of loan is also called a second mortgage. A home equity loan allows you to borrow money against the equity of your home.
- Auto loans. An auto loan helps people to purchase a motor vehicle. In this type of loan, a car you purchase serves as collateral, allowing the lender to seize it if you fail to repay the debt.
- Business loans. A business loan can be taken to purchase inventory equipment, finance business projects, pay wages, or cover other expenses relating to your business. In this type of loan, you can use your equipment, inventory, building, land, and many other things as collateral.
What You Can Use as Collateral for Secured Loans?
Lenders allow borrowers to use many items as collateral. The most common examples of collateral include:
- Property, including equity inside;
- Vehicle;
- Investments;
- Equipment;
- Savings account;
- Collectibles;
- Valuables;
- Etc.
The Bottom Line - Is a Secured Loan Good for Credit Building?
A secured personal loan is an excellent borrowing option, allowing you to get money, paying lower interest and fees than in the case of an unsecured personal loan. You can use a secured loan to build credit, cover various expenses, consolidate debt, etc. Many financial institutions offer different types of secured loans, allowing everyone to choose the suitable option for their needs.
FAQ
How much will a secured loan improve my credit score?
Making on-time payments for your secured loan can help you build credit. For example, a credit-builder loan can raise borrowers' credit scores up to 60 points in the first few months.
Can I be rejected from a secure personal loan?
Yes, you can be denied secured personal loans. For instance, a lender can reject your request if you don’t submit the right documents, have too high DTI (debt-to-income ratio), or your collateral is not eligible.
Can a secured loan affect my credit?
Yes, secured loans can impact your credit history. If your lender reports to one of three major credit bureaus (Equifax, Experian, and TransUnion), your on-time payments can improve your credit history, while missed or late ones can hurt it.
Is it easy to get secured personal loans?
Getting secured personal loans is simpler than unsecured personal loans. If you provide collateral to a lender, it can approve you despite your bad credit and offer larger loan amounts and better terms.
What are the credit score requirements for a secured loan?
Every lender has different eligibility criteria for borrowers. While several loan providers require a credit score of at least 670, other lenders have no credit score requirements.
How much can I borrow with secured loans?
The amount you can get with secured loans depends on the specific lender and your credit score, credit history, value of your collateral, and many other factors. You can see your approval chances and calculate the available loan amount prequalifying on the lender’s website.
