Saturday, May 1, 2010

How do Secured Loans Work?

A secured loan is just a generic term for a specific type of loan. It is “secured” because it gives the lender some sort of security that it will be repaid (other than the personal promise of the person who takes out the loan).

If you are issued a secured loan, you are putting up property as collateral. This means that if you do not repay the loan, the lender is entitled to take the property to ensure that they get their money back. (Since you need property to apply for or receive a secured loan, it is also sometimes known as a “homeowners loan”.)

One reason that people apply for secured loans, as opposed to other types of loans, is that secured loans usually carry a relatively low interest rate. This is because from the bank’s perspective the risk of issuing the loan is greatly decreased, as you are putting up collateral. Since risk and loan interest rates are directly proportional, lowering the bank’s risk tends to lower the interest rate of the loan. Of course, with a secured loan, the person receiving the loan is shouldering more of the risk, even as the bank shoulders less.

Secured loans are a popular way for homeowners to get cash to complete home improvement projects. For instance, you may wish to renovate your bathroom--but not have the money to do this. Using the equity you own in your home as collateral, you can get a secured loan and thus be able to undertake the home improvement project. Such a project might not only please you by improving the look and functionality of your house, but it will probably also increase its value substantially. In this way, a homeowner can nearly break even on home improvement projects, and it is not even necessary to have the cash on hand to finance them! Of course, to do this you must be willing to accept some risk, since you could lose your house if for some reason you are unable to repay the loan.

Before obtaining a secured loan, it is imperative that a person analyze their financial situation carefully. It is always wise to be conservative when estimating personal cash inflows and outflows to avoid being caught in a pinch. But if a person is willing and able to put up their property as collateral, a secured loan is a viable solution to get a low-interest loan.