Taking out a loan may give you immediate access to funds, but it could have a lasting impact on your finances and credit. Here’s what you need to know before signing the dotted line for a secured personal loan.Image source: Getty Images.
Anytime you take out a loan, your lender expects to be paid back in full. Depending on the type of loan, the lender may require additional assurances upfront to ensure you will uphold your end of the bargain.
Taking out a loan may give you immediate access to additional funds, but it could have a lasting impact on your finances and credit. Here’s what you need to know before signing the dotted line for a secured personal loan.
How does a secured personal loan work?
You may be wondering, how is a secured loan different from an unsecured loan? Unsecured loans use your credit score to determine your risk and only provide loans to creditworthy borrowers who have a proven history of paying back their lenders. In contrast, a secured loan requires some type of collateral to ensure full payment is made. If you do not abide by the terms of a secured loan, the lender can take ownership of your collateral, thereby recouping the cost of your loan.
Secured loans come in many forms, with some having more specific contract terms than others. For example, a mortgage loan is secured with your house as collateral, while an auto loan is secured with your car. Other types of secured loans include secured credit cards which are backed by your initial deposit and secured personal loans which are much broader in terms of what they can be used for and what can be used as collateral.
A secured personal loan -- our focus here -- can be used for a variety of reasons, from consolidating debt to paying for car repairs or moving expenses. You will still be required to use an asset you own as collateral, but you typically have more options. Depending on the lender’s requirements, you can use a vehicle that is already paid off, certificates of deposit, your personal savings, or valuable property like your house. You will keep physical control of the asset while you work to pay off the loan, but risk losing your property if you fall behind on payments or default on the loan.
Does a secured personal loan affect my credit?
Secured and unsecured personal loans affect your credit in the same way. When you apply for the loan, an inquiry will appear on your credit report, which might cause a slight dip in your credit score. You may see an additional drop once you have officially agreed to the new loan because your average length of credit history will have changed with the new account. The good news is that both of these scenarios will typically not have a lasting effect on your credit score. What really matters is how you manage the loan.
A secured personal loan can ultimately help or hurt your credit score depending on how you manage monthly payments. You’ll likely get a boost from having an additional type of loan thrown into your credit history -- this shows potential lenders that you can manage a diverse mix of debt. If you make your required payments in full and on time, your credit score will continue to increase over time. On the other hand, if you miss payments or make partial payments, you risk severely damaging your credit score. As with any debt, reach out to your lender immediately if you are having trouble meeting your minimum payment. You may be able to work out an alternative payment plan.
Advantages of secured personal loans
Secured personal loans are generally meant for individuals who don’t qualify for an unsecured loan. Here are some of the upsides of opting for a secured personal loan.
Easier approval -- The approval requirements aren’t as strict because the lender isn’t assuming as much risk since there is collateral up for grabs if you default on the loan.
Credit-building -- When used responsibly, a secured personal loan can help build your credit. This requires making on-time monthly payments throughout the life of the loan.
Bigger loan amounts -- With your property on the line as collateral, you may qualify for a larger loan amount than if you were to apply for an unsecured loan.
Disadvantages of secured personal loans
As with any loan, you are potentially putting yourself at risk if you are not fully committed to managing your repayment. Here are the downsides of secured personal loans.
Unmanageable debt -- Just because you qualify for a larger loan amount doesn’t mean you should automatically borrow that much. Carrying too much debt puts you at risk financially and ties up your future money that could be spent elsewhere.
Risk losing the collateral -- If you miss payments or default on your loan, your lender can seize control of your property.
High interest rates -- The best personal loans come with low interest rates. Even secured loans can offer very low interest rates because they’re secured with collateral, but some predatory lenders also offer secured loans, such as title loans, with sky-high interest rates because they’re targeted toward people with bad credit who have no other options.
What to look for in a secured personal loan
- Low interest rates: Shop around for the lowest interest rate. Interest can quickly add up, especially if the loan is over a long time period. High interest rates are usually a sign of predatory lending practices, so pay attention to any red flags.
- Low fees: You may have to pay more than just the cost of the loan with interest. Ask for clarification about associated fees. Some lenders charge outrageous application fees, origination fees, monthly fees, and prepayment fees. You may also be expected to cover the cost of having your property appraised to determine the current value. Look for lenders who charge minimal fees.
- Manageable monthly payments: Take out only what you can afford on a monthly basis. A shorter loan period may save you interest over the life of the loan, but you’ll also have higher monthly payments. You should aim to pay off the loan as quickly as possible to avoid paying extra interest, but you need to be able to ensure you can make the required monthly payment or risk losing your property.
- Collateral requirements: Different lenders may accept different collateral. Make sure you have what’s required whether it’s a paid off car, a savings account, or another form of acceptable collateral.
Is a secured personal loan a good idea?
It can help you in multiple ways, but only if it’s used for something necessary and paid off responsibly. Don’t feel like you have to immediately move forward with the first lender. The first isn’t always the best, and you likely have more options than you think. Avoid predatory lenders by arming yourself with knowledge.
Look for low interest rates and always ask about associated fees. Don’t take on a financial burden you can’t handle no matter how tempting a purchase might be. Keep your monthly payment at a reasonable amount. Remember, if you miss payments you risk losing your collateral and trashing your credit to top it off.
There are certainly good reasons to get a personal loan. However, debt should be avoided whenever possible, so only take out a personal loan if you really need to and are confident you will be able to repay the loan in full. If the contract terms allow it, plan to pay off your loan early to save you money in the long-run.