A secured loan or secured debt is when the borrower has committed to give the lender certain assets, such as a real estate property or a car, if he or she defaults, i.e. fails to make payments. The lender has recourse to seize the asset and sell it to recoup the money lent.
The asset the borrower puts up as security is called the ‘collateral’ on the loan. The practice of pledging an asset as collateral on a loan is known as hypothecation.
When a homebuyer takes out a mortgage, the house being bought is put up as collateral, making it a secured loan. If the mortgagor (borrower) defaults, the lender will take possession of the house and sell it in order to recoup its money – this is known as foreclosure.
In the situation on the right, Auntie Iris has made sure she can get her money back.
If after selling the collateral there is not enough money to pay off the debt, the lender may try to obtain a deficiency judgment against the borrower for the remainder. With a non-recourse secured loan the collateral is the only claim the creditor has against the borrower.
A secured loan is the opposite of an unsecured loan, as occurs with most credit card purchases when the issuer lends the card holder money and no collateral is involved.
As the risk is lower for the lender, secured loans tend to charge lower interest rates compared to unsecured debt. Other factors will also determine how much interest the lender will charge, including the borrower’s employment status, credit history, age, and ability to repay.
Advantages of a secured loan
1. As mentioned above, with this type of loan the lender is relieved of much of the risk, which permits the second advantage.
2. The borrower is more likely to get better terms than what would be available with an unsecured loan. He or she can probably borrow more and pay back over a longer period. In many cases, without putting up collateral the borrower might not be able to get the loan he or she wants.
3. For individuals with a poor credit rating, this may be the only way they can borrow money.
4. A secured loan is a good way to improve your credit rating (as long as you pay on time).
According to Barclays Bank “An alternative to taking a secured loan is to increase the mortgage on your property.”
Cambridge Dictionaries Online says secured debt is:
“A debt or debts that include an agreement for the lender to take particular assets from the borrower if the money is not paid back.”
Video – Unsecured and secured loans