Definition and Examples of Secured Loans
How do secured loans work?
Secured loans vs. insured loans
Types of secured loans
Definition and Examples of Secured Loans
A secured loan is a loan backed by a third party who will repay the loan if the borrower defaults. A secured loan means that a third party promises to pay the loan if the borrower fails to repay it. Secured loans allow high-risk borrowers access to the financing they need. When a loan is secured, lenders are more willing to work with borrowers who are typically not considered good candidates for a loan.
Alternative definition: A loan that a third party will pay off if you cannot. Alternative name: Secured loan
For example, the federal government offers guaranteed loans for borrowers who may not be able to obtain a home mortgage in other ways. Borrowers apply for a mortgage through a private lender, and the government backs the loan. These loans are typically backed by the Department of Veterans Affairs (VA), the Federal Housing Administration (FHA), and the U.S. Department of Agriculture (USDA).
How do secured loans work?
Borrowers looking to purchase a home may not always meet the credit or down payment criteria to qualify for a traditional loan. For instance, they may not have a high enough credit score, or they may not be able to afford a 20% down payment.
The federal government offers guaranteed loans for these borrowers. Borrowers apply for a loan through a private lender, and either the VA or FHA backs the loan. This allows borrowers to gain access to the financing they need, while protecting the lender from default risk.
Secured loans vs. insured loans
It is easy to confuse secured loans with insured loans, but they are not the same thing. Both types of loans are less risky for the lender, but they operate in different ways.
A secured loan is backed by a third party, and if the borrower defaults, the third party pays off the loan. With a secured loan, the borrower may be required to pay a usage fee.
On the other hand, an insured loan is backed by an asset that is used as collateral, and the lender will seize the asset if the borrower defaults. For example, if you take out an auto loan, the car is used as collateral. If you default, the lender will repossess your car.
Types of Secured Loans
Mortgages are not the only type of secured loan programs available. Let’s take a look at three other examples of secured loans:
Student loans: The federal student loan program is another example of a secured loan. Borrowers begin by filling out the Free Application for Federal Student Aid (FAFSA), and the loan is backed by the Department of Education. Federal student loans do not require any credit requirements and come with low-interest rates.
Payday loans: Payday loans are usually small loans of $500 or less, and the balance is due on the next payday. Your upcoming paycheck serves as collateral for the loan, and the lender will electronically deduct from your account on the agreed date. However, payday loans can come with interest rates as high as 400%, which is why they are banned in some states.
Federal mortgage loan programs: VA, FHA, and USDA offer different types of guaranteed mortgage loans designed to make homeownership affordable. For example, the USDA guarantees 90% of the money that the lender provides to the borrower for single-family home mortgages.
Small Business Administration Loans: The Small Business Administration provides guaranteed loans to help small businesses access the financing they need. The business applies for the loan through a bank or lender, and the Small Business Administration guarantees the loan for a certain percentage.
Take
The lesson
A guaranteed loan is supported by a third party, which can be an individual, company, or organization. Guaranteed loans provide high-risk borrowers with access to financing while offering protection to the lender. A guaranteed loan is not the same as a secured loan. Secured loans are backed by an asset used as collateral, while guaranteed loans are supported by a third party. Mortgage loans, federal student loans, small business administration loans, and wage loans are all examples of guaranteed loans.
Source: https://www.thebalancemoney.com/what-is-a-guaranteed-loan-5193926
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