Borrowing with backup: secured debt explained

We all need a little financial boost sometimes. Secured debt can be a powerful tool to help you reach your goals. Whether you're considering a mortgage, an auto loan, or just want to understand your options better, knowing the ins and outs of secured debt can help you make the choice that’s right for your situation.

Secured debt is simpler than you might think. It's all about using what you own to get what you need. We’ll break down the basics of secured debt and explore how it could work for (or against) you.

What is secured debt?

Secured debt is debt that's tied to collateral. Collateral is something of value that you pledge as a guarantee that you’ll repay the loan. If you don’t repay the loan, you could lose your collateral. 

Mortgages and home equity loans are secured loans, guaranteed by the home you borrowed against. Similarly, auto loans are secured loans guaranteed by the vehicle.

The types of collateral for secured loans can include:

• Cars or other vehicles

• Homes and land

• Money

• Life insurance policies

• Business equipment (if you own a business)

Secured loans explained

A secured loan is an installment loan that you pay back over time, usually with interest. 

Interest rate types

Some secured loans have an interest rate that doesn’t change (a fixed interest rate). Most car loans, for example, are fixed-rate loans. With a fixed rate, your payments are predictable over the long term. 

Other secured loans have a rate that could change from time to time. Those are either called variable interest rates or adjustable interest rates. Credit cards typically have a variable interest rate. If you get a mortgage with a rate that could change, it’s called an adjustable-rate mortgage or ARM. With a variable or adjustable rate, your rate could fluctuate, causing your payment amounts to change.

Secured loan interest rates

When you compare secured vs unsecured loans, you’ll find that secured loans have lower interest rates on average. That’s because the collateral lowers the risk of loss for the lender, so they can charge less.

Repayment terms

The amount of time you'll have to repay a secured debt can vary. Car loans, for example, often have repayment terms ranging from two to seven years. A mortgage, on the other hand, might have a repayment term of 30 years. 

Secured credit cards explained

Secured credit cards are credit cards that require collateral. The collateral is almost always cash, and the amount you deposit often determines the credit limit on the card. For example, if you send the lender $200, you might get a credit card with a $200 credit limit. 

Your collateral isn't an advance payment against purchases. You still have to pay your bill just as you would with any other credit card. If you don’t pay the bill, you could lose your deposit. After you use the card responsibly for 6-12 months, you can apply to have your deposit returned to you. Some lenders return it automatically.

The payment terms depend on you. If you make a purchase, you could pay it off immediately, in a month, in a year, or over whatever time period you choose. The timeline depends on what you can afford and whether you choose to pay more or less. 

Unless your balance is very low, credit cards let you make minimum payments for less than the full amount you owe. If you do this, you’ll pay interest on the balance that you owe, and take longer to pay it off. But as long as your payment is made by the due date, your collateral won’t be at risk.

How does collateral work for a secured debt?

Collateral is like an insurance policy for lenders. If you get a secured loan and don't pay it back, the lender can keep your collateral to make up for it. For example, if you don’t pay your mortgage, the lender could foreclose on the home and sell it to recover what you owe. 

Home equity loans and home equity lines of credit (HELOCs) are mortgages. The home is the collateral.

Before you can get a secured loan, the lender will evaluate your collateral to make sure it qualifies. This usually involves determining how much the collateral is worth, and confirming that you own it. 

Examples of secured debt

Some examples of secured debt include:

• Mortgage loans. If you don't have cash to buy a home, you'll need to get a loan. Your home is the collateral for a mortgage.

• Home equity loans and HELOCs. A loan against your home equity. Your home is the collateral for the loan.  

• Auto loans. When you get a car loan, the vehicle you’re buying is the collateral. 

• Secured personal loans or lines of credit. The lender may accept an account (like a Certificate of Deposit), valuables such as fine art, or other items as collateral.

• Pawnshop loans. These are typically expensive, short-term loans secured by something valuable, like a piece of jewelry, that you hand over when you get the loan.

What happens if you default on a secured debt?

Defaulting on a debt means that you stop making payments. Each lender decides how many payments you can miss before they consider your loan to be in default.

Defaulting on a secured debt could lead to negative consequences:

• Credit score damage. Payment history is a significant factor in your credit score and missed payments could cost you points. 

• Collections. Once a secured debt goes into default, the lender can start collection actions. You might get phone calls or letters asking for payment. 

• Loss of collateral. If a secured debt goes unpaid, you might forfeit your collateral to the lender. The lender may need to go through a legal process like foreclosure or repossession first to claim your collateral. 

If you file for bankruptcy protection, there may be ways to avoid losing your collateral on a secured debt. 

In Chapter 7 bankruptcy, if you want to keep your collateral, you'll have to either redeem it or reaffirm it.

Redeeming secured debt means making a lump-sum payment to clear what you owe. Reaffirming means making an agreement with your creditor that allows you to keep paying the debt even though you're including it in your bankruptcy. 

Chapter 13 bankruptcy allows you to set up a payment plan with your creditors that covers secured and unsecured debts. People usually choose Chapter 13 if they want to make sure they can keep their assets. 

How to get help with secured debt

If you're struggling to manage your secured debt, you've got options for dealing with it. 

Bankruptcy is one possibility we've already covered. Other solutions might include: 

• Forbearance. Your lender might allow you to take a ‌temporary break from making payments. Find out the details. In some cases, you’ll need to catch up on all of the skipped payments, which could be difficult. 

• Sell the asset. You could sell the collateral and use the money toward paying off the debt.  

• Free up cash flow by negotiating other debts. If you have unsecured debts like credit cards, you could try negotiating with your creditors to accept less than the full amount you owe. They might agree to let you make a lump-sum payment that clears the debt, or to lower your interest rate and make the payments more affordable. Strategies like these could free up cash in your budget and make it easier to manage the payments on your secured debts.  

You don't have to manage secured debt alone. A debt expert could look at your finances and help you figure out an actionable plan. That could give you peace of mind if you're not sure what your next move should be. 

What's next

• Review your budget to figure out how much you're paying toward secured debt monthly. 

• Talk to a debt expert to discuss debt solutions. 

Use a debt payoff calculator to estimate how much you could save by negotiating some of your unsecured debts.