Secured credit is credit given by a lender in exchange for a valuable asset given by the borrower as collateral. The collateral “secures” the debt. This arrangement allows the creditor to take possession of the asset as payment if the borrower should default on the loan. That enables the creditor to recoup some or all of the loan amount still owed. Some examples of collateral used to secure credit agreements include real estate, bank accounts, vehicles, investments, money, and precious metals.
When you apply for secured credit, the lender will request the collateral to "back" the loan. A lender will typically want assets that are liquid, meaning they can be easily converted to cash. They should also have roughly the same value as the amount being borrowed. In addition to the types of collateral listed above, other high-value items and collectibles can also be used for collateral, such as works of art or valuable coins.
With secured credit, there’s less risk for the lender since they have collateral. This makes secured credit easier to get, and often with lower interest rates. But depending on the collateral being put up, it will often take longer to approve secured credit accounts. Assessing collateral’s value can be a lengthy and time-consuming process.
Even though the credit is secured by something of value in this case, it’s important to know what’s at stake if you default on a secured credit account. If the foreclosed or repossessed assets you put up as collateral don’t sell for the total amount you owe, the lender can demand payment for the remaining balance. Also, foreclosures and repossessions of collateral will stay on your credit report for up to seven years. This will make it difficult to obtain credit in the future.
Here are some common types of secured credit:
Mortgages: Your home is the collateral for the loan. If you default on a mortgage, the lender can foreclose and you will lose your home.
Home equity loan or line of credit: Also known as a “second mortgage,” you use the equity in your home as collateral. Just like a traditional mortgage, you can lose your home if you default.
Auto loans: Similar to a mortgage, but traditionally, the vehicle being financed is the collateral. Also, if you default, the lender can repossess the vehicle.
Secured credit cards: The lender will require a security deposit, usually a $200 minimum, against the secured credit card’s credit limit. The deposit is fully refundable when you close the account with a $0 balance. But if you default on the account, the lender can withdraw funds from the security deposit as payment.
Secured personal loans: The concept is similar to a secured credit card because they’re for borrowers who may not qualify for an unsecured loan. Banks and credit unions offer secured personal loans where borrowers put up savings accounts or CDs as collateral.
Title loans: A borrower can put up a paid-off vehicle as collateral for this type of secured personal loan. The lender will hold the title for the vehicle for the duration of the loan and can assume ownership of the vehicle if the borrower defaults. Title loans typically have high interest rates because of the vehicle’s depreciation.
Be sure to know the difference between secured and unsecured credit before you apply. While a borrower has to put up collateral to obtain secured credit, unsecured credit is not backed by any collateral.
If you’re late in paying or default on an unsecured credit account, the lender may not immediately seize your assets as repayment, but they could do so after a court battle. The lender may file a lawsuit and get a judgement against you. This could ultimately result in your wages or your bank accounts being garnished. Most credit cards, student loans and personal loans are among the common types of unsecured credit.