Secured loan

The security in a secured loan is the lender's, not the borrower's. When the loan is made the lender records a lien, a legal claim on one specific asset, and the claim stays in place until the last payment clears: a car with a loan on it carries the lender's name on the title, and a house with a mortgage cannot change hands without the mortgage being paid off at closing. If the payments stop, the lender can take the collateral and sell it, and the borrower usually still owes any shortfall, which is the trade that buys the lower rate: a $15,000 car loan at 6.9% instead of an unsecured loan at 12.9% saves $2,653 of interest over five years.

In a sentence

• "The mortgage is a secured loan, so the house is on the line if we stop paying; the credit card is not."
• "A secured loan at 6.9% instead of an unsecured one at 12.9% cut the payment on $15,000 by $44 a month."
• "Because the car is collateral, the auto loan is a secured loan, and the rate reflects that the lender can repossess it."

How it works

1. The lender takes a lien on the collateral when the loan is made. On a car, the lender is listed on the title; on a home, the mortgage is recorded against the property.
2. The loan is sized against the collateral's value. The loan-to-value ratio, the balance divided by what the asset is worth, sets the rate offered and the down payment required, and on a conventional mortgage it decides whether private mortgage insurance is charged, below 20% down.
3. Payments run on the loan's own schedule, an installment loan for a mortgage or a car loan, a revolving line for a home equity line of credit.
4. If the borrower defaults, the lender takes the collateral, by repossession for a vehicle or foreclosure for a home, and sells it toward the balance. In most states, if the sale brings less than what is owed, the borrower still owes the difference, the deficiency, plus the costs of the sale.
5. When the loan is paid off, the lien is released and the asset is owned free and clear.

Loan-to-value = loan balance ÷ collateral value

An example

A $15,000 loan over 60 months, once secured by the car it buys and once as an unsecured personal loan; the rates are the example's assumptions.

The secured loan costs $44.22 less a month and $2,653 less over the term, and its balance falls faster because less of each payment is interest. The collateral is the price of the discount. If the car is worth $18,000 on the day of purchase, the loan is 83% of its value; and if the payments stop two years in, with $9,611 owed and the car sold at auction for $7,000, the borrower owes the $2,611 difference plus the lender's costs, and no longer has a car.

Why it matters

Secured or unsecured is the first thing to know about any debt, because it decides what is at risk when a month goes wrong and which bills get paid first. A missed card payment costs a fee and interest; missed mortgage or car payments, repeated, cost the house or the car, which is why a household that has to choose pays the secured loans first. It also says what a consolidation is really doing: moving card balances into a home equity loan lowers the rate and puts the home behind debt that had nothing behind it. The lower rate is real, as the example shows, and so is the collateral, which is what the lower rate is paying for. The same arithmetic names the rule for borrowing against anything: the balance should fall faster than the asset loses value, or the borrower is underwater, owing more than the asset would bring.

Secured loan versus an unsecured loan

An unsecured loan is backed by the borrower's promise and credit history alone; a secured loan is backed by an asset the lender can take. Most credit cards, student loans, personal loans and medical debts are unsecured, and a lender owed on one of them can send the balance to collections or sue, but has nothing specific to seize. Because the lender's risk is higher, unsecured rates are higher, the amounts smaller, and the approval leans harder on the credit score. Mortgages, auto loans and home equity lines are secured, with lower rates, larger amounts, longer terms, and the collateral at stake. See Revolving credit for the unsecured kind most households carry and Mortgage for the secured kind most households hold.

Common questions

Is a secured loan the same as a mortgage? A mortgage is a secured loan, the largest most households ever have, with the home as collateral. Auto loans, home equity loans and lines of credit, and secured credit cards are secured loans too. The term covers any loan with an asset pledged behind it.

Is a secured loan bad? Not by itself. It is how most homes and cars are bought, and its rate is the cheapest borrowing most households can get. The risk is specific: the collateral is lost if the payments stop, so a secured loan should be sized to a payment that survives a bad month, and moving unsecured card debt onto the home moves the home into the risk.

What is a good loan-to-value ratio? Lower is safer for both sides. On a conventional mortgage, 80% or less, which is a 20% down payment, avoids private mortgage insurance; on a car, a balance below the car's resale value from the first day means the car can be sold to clear the loan if it has to be. The loan does not change when the collateral loses value, so a balance above the asset's value is underwater, and the gap is money owed on something that cannot be sold to cover it.

Is a secured credit card a secured loan? Yes, in structure: a cash deposit is the collateral, it usually sets the limit, and it is kept if the balance goes unpaid. The account itself is revolving credit, and the deposit is returned when the account is closed with nothing owed or upgraded to an unsecured card.

Go deeper

• The Loan calculator estimates the monthly payment on a car, personal or student loan and the total interest over its life, so a secured rate and an unsecured one can be compared on the same amount.
• The Mortgage calculator estimates the full monthly payment on a home, principal and interest plus property tax, insurance, HOA dues and PMI, the insurance charged while the down payment is under 20%.
• Why your net worth drops when you buy a car keeps the collateral and the loan on separate lines and shows what being underwater looks like from day one.