What Is Secured Debt?
6 MIN READ
Published April 06, 2023 | Updated November 10, 2023
It is among the top money-lending opportunities with less risk for financial institutions and a comfortable solution for borrowers.
Let's understand the concept of secured debt in detail and its associated pros and cons.
What Is Secured Debt?
Secured debt refers to a type of debt that is backed by collateral or assets. In other words, the borrower pledges specific assets (such as a home or a car) to the lender as a form of security in case they fail to repay the debt.
If the borrower defaults on the loan, the lender has the right to seize and sell the collateral to recover the outstanding debt. The lender is generally entitled to the proceeds of the sale up to the amount owed, with any excess amount being returned to the borrower.
A lien is a legal obligation placed on the asset/s of the debtor on behalf of the creditor, and it can be voluntary or involuntary. In a voluntary lien, the debtor offers his asset as collateral against his debt.
In comparison, an involuntary lien is placed on the debtor's assets by an outside authority (such as a court order) to collect unpaid debt.
Taking a secured debt is similar to a pawnshop arrangement where you pawn your valuable items to get money. You get your pawned item back when you repay the money with interest and within an agreed time frame.
On the other hand unsecured debt, the other form of debt is not backed by collateral and poses more risk to the lender's capital. Some common examples of unsecured debt are credit cards, personal loans, and student loans.
Examples of Secured Debt
These are some common forms of secured debt:
It is the most common type of secured debt and also the leading source of debt for Americans in 2023.
In a mortgage loan, you pledge the real estate property you plan to buy as collateral against your debt. By doing this, you authorize the creditor to legally seize your property if you fail to pay your mortgage payments.
Banks generally start this foreclosure process after you fail to pay four consecutive installments of your mortgage loan while also not providing valid reasons through a mortgage assistance application.
Mortgage loans are typically taken for 15 to 30 years and have interest rates of up to 10%.
Another similar example of this are home equity loans, where the borrower already owns the property or a part of it.
These loans are secured by the vehicle (car, boat, truck, etc.) you buy using the loan.
Also called auto loans, these generally have a repayment period between 12 to 60 months, and the interest rates offered will depend upon your credit history and creditworthiness.
The most common type of these is a car loan, and the loan payments are made in monthly installments.
Life Insurance Loans
This type of loan is secured against a life insurance policy through its cash value as collateral. The debtor repays the debt over the term in monthly installments.
If they pass away, the death benefit paid to the beneficiaries is used as collateral to deduct the outstanding amount.
What Happens If a Secured Debt Is Not Paid?
Since a secured debt is backed by collateral, the creditor can seize and sell the collateral to obtain the outstanding balance of the debt when the borrower defaults.
Seizure of collateral is easy for the creditor in the case of a voluntary lien. If there is an involuntary lien on the collateral, the creditor can obtain a court order to seize the assets.
Failure to pay a debt will also damage the borrower's credit score.
In some rare circumstances, the creditor will forgive the secured loan if retrieving debt from the collateral is impossible.
Advantages of Secured Debt
Here are a few advantages of secured debt:
Higher Loans and Longer Payback Period
Secured debts can be used to borrow large sums of money from creditors because of the involved collateral. Since there is a guarantee of repayment, the amount of debt you can take depends upon the value of the assets you are ready to lien. The loan repayment period can be as long as 30 years, so you have enough time to get things in order.
Lower Interest Rates
Since these debts are protected by collateral, the interest rates are low and generally come under 10% annually. It is far better compared to the higher interest rates of unsecured debts, which can be as high as 36% for personal loans.
High Chances of Allotment
Getting secured loans can be comparatively more accessible than an unsecured loan if you have a reliable source of income.
Good for Credit Report
Taking a secured debt and paying the installments on time keeps your credit score healthy. It opens up possibilities for debt applications being granted with ease in the future.
Disadvantages of Secured Debt
Here are a few disadvantages of taking a secured debt:
Loss of Collateral
Upon failure of repayment, you risk losing your assets pledged as collateral. This can leave you in financial ruin as well as with a damaged credit score.
You Pay More Interest
You can pay significantly over time due to the long-term nature of secured debts and debtors trying to spread out payments.
May Take Some Time
Creditors can take as much as 60 days for the application process of a secured debt. This happens due to the time-consuming verification of the collateral.
How to Pay Off Secured Debt
You can either pay off the secured debt over the agreed period or make partial payments to close it even before.
Here are some steps you can take to help you pay off your debt with ease:
- Plan your payments: Consult with your creditor for a prepayment plan with lower fees before you take the debt.
- Compare rates: Always compare interest rates from different creditors when looking for a secured debt.
- Get a debt relief plan: If you can’t pay your installments for some reason, talk to your creditor about this immediately. Many creditors offer some relief plans based on the circumstances.
- Consolidate your debts: If you have multiple secured and unsecured debts, look for a debt consolidation plan and a balance transfer of all your debts into one account with preferably a lower interest rate. Doing this can also improve your credit history and financial health.
If you already have a secured debt and are struggling to pay, now is the right time to look for a debt relief solution. While some issuers offer their own options, several debt relief companies can mediate and help you with relief plans.