Secured debt makes up a big part of the total consumer debt in the U.S. For lenders, it’s among the top money-lending opportunities with less risk, and for borrowers, it’s a viable low-cost borrowing option. 

Like with any kind of debt, there are some risks involved with secured debts like car loans and mortgages, so it’s important to understand how secured debt works, along with its 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 ownership in one or more 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. Once you repay the loan in full, you get full ownership of your collateral back. 

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, at the initiation of the loan, as collateral against his debt to the lender. 

For example, when you borrow a mortgage loan, there’ll be a lien on the house. This is a normal part of the home-buying process, and because it is a secured loan (versus an unsecured loan), the generally low-interest rate on mortgage loans is how most Americans can afford to buy a home at one or more points during their lifetime.

In comparison, an involuntary lien is placed on the debtor's assets by an outside authority (such as a court order) to collect on an unpaid debt, no matter whether it was secured or unsecured when it was issued.

On the other hand, unsecured 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:

Mortgage Loan

It is the most common type of secured debt and also the leading source of debt for Americans in 2023. Mortgages are installment loans with a repayment period of 15 to 30 years. The interest rate can be either fixed or variable.

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 (and sell) your property if you fail to repay the loan as agreed. 

Banks generally start this foreclosure process after you fail to pay four consecutive installments of your mortgage. Homeowners also have the option of a short sale if they’re unable to make payments. However, it’s important to understand the differences between a short sale and foreclosure.  

Vehicle Loans

These loans are secured by the vehicle (car, boat, truck, etc.) you buy using the loan. Auto loans generally have a repayment period between 24 to 72 months, and the interest rates you qualify for will depend on your credit score, your recent credit history, the age of the vehicle, and the purchase deal you work out with the dealership.  

This type of loan is secured against a life insurance policy through its cash value as collateral. You can repay the debt over a specified term via monthly installments. If you don’t pay back the loan during your lifetime, it will be deducted from the death benefit your beneficiaries would receive when you pass away.  

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 recover the outstanding balance of the debt when you default. 

Seizure of collateral is easy for the creditor in the case of a voluntary lien because the process is spelled out in the secured loan’s terms. If there is an involuntary lien on the collateral, the creditor must obtain a court order to seize the assets if the loan is left unpaid for a long enough period. Failure to pay any debt issued by a lender who regularly reports your loan information to your credit reports will also damage your credit scores with any one or all of the major credit reporting bureaus.

Advantages of Secured Debt

Here are a few advantages of secured debt:

Higher Loans and Longer Payback Periods

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 backed primarily by a physical asset, the amount of debt you can take depends upon the value of the assets you are ready to submit for lien. Secured loans also come with longer repayment periods, sometimes as long as 30 years, making monthly payments much more affordable.

Lower Interest Rates

Since these debts are protected by collateral and represent a lower risk to the lender, the interest rates are lower compared to unsecured loans. Even when borrowing a secured loan with bad credit, the interest rates you may qualify for are lower compared to personal loans for bad credit, which can be as high as 36%.

High Chances of Qualifying

Qualifying for a secured loan is easier compared to an unsecured loan because the lender has security. If you have bad credit, these loans are more accessible. 

Good for Credit Report

Taking on a secured debt and paying the installments on time keeps your credit score healthy. As your credit score improves, it will be easier to qualify for loans at competitive interest rates.

Disadvantages of Secured Debt

Here are a few disadvantages of taking a secured debt:

Loss of Collateral

If you fail to repay the debt, you risk losing ownership of your assets pledged as collateral. This can also leave you with a damaged credit score and finances, especially if you lose a large and valuable asset like a home.

You Pay More Interest 

You can pay significantly more over time in interest (i.e., dollars in interest) due to the longer repayment term. While your monthly payments can be more affordable, you’ll often pay more in total interest, even if the interest rate is lower, because you are paying interest on the loan for so much longer (30 years for a mortgage loan vs only 3-5 years for an unsecured loan).  This disadvantage assumes that you don’t pay the secured loan off early.

Secured Loans May Take Some Time to Get Approved 

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. If you’re in need of funds for an emergency, you may want to consider another unsecured loan option, like a same-day loan

Choosing Between Secured vs. Unsecured Debt

Secured and unsecured debts both have their purpose, but choosing the right option depends on your financial situation, creditworthiness, and purpose of borrowing. 

A secured loan is a better option when you want to borrow a larger amount, for example, to purchase a home or a car. It may also be a good option if you have poor credit and are unable to qualify for unsecured loans, which are based solely on your credit and income level. Check your budget to ensure you’ll be able to afford installments, both now and in the future before you borrow. 

An unsecured loan, such as a personal loan, can be a better choice if you don’t have collateral. It may also be a better choice if you have good or excellent credit and qualify for lower interest rates, in general.  

Weigh the Pros and Cons of Secured Debt Before Borrowing

With lower interest rates and longer terms, secured debt can be an attractive option for many borrowers. While these loans are more accessible, it’s also important to weigh the pros and cons before you borrow since your collateral can be at risk if you run into trouble repaying. 

If you already have a secured debt and are struggling to pay, now is the right time to look for a debt relief solution

Some lenders do offer debt relief for low-income borrowers, so you may want to start your search there.