Secured loans utilize assets or property as a way to reduce risk for the lender. Borrowers enjoy lower interest rates because of this decreased risk, but they may find themselves in danger of losing the property if they don't pay the loan. There are different secured loans for a variety of circumstances, and each type has its own terms, advantages and drawbacks.
A mortgage is a loan secured by the property being purchased. This means that the lender will foreclose the property and sell it at auction if a borrower fails to pay his mortgage. Because homes are such large purchases, mortgages generally last 15 to 30 years, and the interest is usually only a few percentage points above the current prime rate set by the Federal Reserve.
The most common types of mortgages are fixed-rate and adjustable-rate mortgages. Fixed-rate mortgages have an interest rate that remains the same over the life of the loan, providing a consistent monthly payment. Adjustable-rate mortgages start out with low interest rates that rise after a specific amount of time, usually three to five years.
Usually, borrowers must provide a down payment that equals 10 to 20 percent of the home's selling price. Borrowers who utilize government loan programs may only have to provide a 3.5 to 10 percent down payment. The exact amount of a down payment for any mortgage depends on the borrower's credit history.
A vehicle loan uses the car being purchased as collateral. The lender pays the full price of the car to the dealership and allows the borrower to pay off the car in monthly installments. In exchange, the lender charges interest on the borrowed amount. Lenders check a borrower's credit history before approving the loan. People with poor credit can still qualify for car loans, but the interest rate is often higher than it would have been for a borrower with good credit, and a 10 to 20 percent down payment may be required.
CD- and Savings-Secured Loans
Loans that are secured by a certificate of deposit or savings account funds are often utilized to build credit by people with thin credit files or poor credit history. The bank places a hold on the funds in the account and provides a loan for up to 95 percent of CD or savings account funds. The lender will use the other 5 percent to recoup interest and collection costs if the borrower defaults. Borrowers do not have access to the funds until the loan is repaid.
Title loans are short-term loans that use paid-off vehicles as collateral. The vehicle must be operational and in good condition to qualify for a title loan. Often, the car must also have full-coverage insurance. Lenders evaluate the vehicle for cosmetic and mechanical defects and use vehicle pricing guides, such as Kelley Blue Book, to determine the car's value. In general, the amount of the loan is no higher than half of the value of the vehicle, to ensure the title loan company can recoup the loan and repossession costs in the case of borrower default. Title loans do not require credit checks, but the borrower must have steady income to show he can repay the loan. Unlike most secured loans, title loans often have high interest rates that can dramatically increase the cost of the loan.
Pawnbrokers provide short-term loans, and, in exchange, place a temporary lien on the property the borrower offers as collateral. The most common items borrowers use as collateral for pawnbroker loans include electronics, tools, jewelry, musical instruments and, depending on the state, firearms. The amount of the loan depends on the value of the collateral which, in turn, is determined by the item's condition and the current demand. The pawnbroker gives the borrower a time frame by which he must repay the loan plus interest. If the borrower does not repay, the pawnbroker will take ownership of the collateral and put it up for sale in the pawn shop.
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- Pros & Cons of Borrowing Money From a Financial Institution
- How Does a Car Title Loan Work?
- What Does a Charge-Off Mean on a Car Loan?
- Long-Term Bank Loans: Advantages & Disadvantages
- Using Land Titles as Collateral for Building Homes