Why Should You Choose a Secured Loan?

It's important to note that in the world of banking and finance, a good credit score is more important than goodwill especially for SMEs because that’s what gets your loan application approved. So, if you are low on capital and your credit score, then here’s a bit about secured loans. You can avail this secured loan even if you have a low credit score.      
 

What is a Secured Loan?

Secured loans are loans that are granted against some form of guarantee or security. It’s the lender’s way of saying, “I trust you but what if you fail to return our money on time.” And so, you put something of value as a guarantee. In financial terms, it is called collateral. It can be anything from property to jewellery, which the lender can sell to recover his money, in case you do not repay the loan.

So, why are they more popular? Well, simply because of higher borrowing limits, lower interest rates and extended repayment periods, secured loans offer many perks. On contrary, in an unsecured loan like personal loan, no collateral is involved and so the lender is at a risk. Thus, he levies a higher interest rate and offers a low borrowing limit. You must have a good credit history and a steady source of high income to get an unsecured loan approved.

Types of secured loans

 

1. Loan against Property / Mortgage

   This loan requires you to put your home or real estate property at stake. The loan amount approved is 80% to 90% of the current market value of your property. These loans have low-interest rate, but need proper paperwork for approval. In addition to that, the condition of the property is also considered by the lender.
    

1. Term Loan

   A term loan is a loan that has to be repaid in regular payments over a period of time with interest rates not being constant. Term loans usually last between one and ten years. However, in some cases, it may last as long as 30 years. 
    

1. Working Capital Loan

   It is not used to buy assets or make investments. It helps in day-to-day functioning by taking care of accounts payable, wages, etc.

 

1. Bill / Invoice Discounting

   What happens when your customers delay the payment? It can hinder you from taking new orders. To overcome this, businessmen opt for bill or invoice discounting options. It is a loan given against the money that is expected to come in near future but charging a fee for it.
    

1. Supply Chain Finance

   This is a way of optimizing the cash flow. The supplier sells his invoices to a bank at a discount as soon as the buyer agrees to buy them.  Now the bank deals with the buyer, who gets more time while the supplier gets the money quickly.
    

1. Machinery Loan

   Machinery loan is provided mostly to small and medium enterprises for the purchase of new machinery which is essential for the smooth conduct of their business. It can also be taken to maintain or repair the existing machinery.
    

1. New or Pre-Owned Car Loan

   Car, being the collateral here, the lender elevates the car and offers the loan accordingly. The borrower can then pay off in instalments. In some cases, the buyer has to make a down payment. If any default on the payments, the bank has the right to repossess the car.
    

1. Two-wheeler Loan

   A secured two-wheeler loan has a lower rate of interest compared to an unsecured loan - the reason being the loan is secured usually against the vehicle.
    

1. Medical Equipment Finance

   A Medical Equipment Finance will help you to buy equipment with the latest technology. No need to use any property as security as the equipment itself can be collateral.
    

Also Read: Secured vs Unsecured Loans, Which One to Choose
 

Popular Collateral or Assets Types

 

1. Real Estate or Property:

   A property as collateral gives a certain assurance of repayment; this helps to lower the interest rate because in case you fail to pay your debts, the lender gets a home to sell. The interest rates get lower with good credit scores as well.
    

1. Invoices:

   As discussed above, the lender pays you as you wait for your payment, which the lender can collect on your behalf.   
    

1. Savings / Fixed Deposits

   Lenders offer savings-secured or certificate-secured loans to their customers. Your savings become your collateral and if the lender is generous enough, you even earn interest on it.
    

1. Inventory

   One can get asset-based lending - it happens in cases where a big contract is in hand but rolling it off requires money. Slightly tricky how it pans out, but lenders use the purchase order/ contract as the collateral.
    

1. Blanket Liens

   It means everything that you own can be seized by the lender in case you default.
    

Advantages of Secured Loans

 

1. Low-Interest Rates

   The greatest plus point of a secured loan is the low-interest rates. This is because the lender takes less risk as your home or real estate property is secured against the loan. In case of a default, the collateral can be seized.
    

1. High Loan Amount

   Low-interest rate and high loan amount. What more can you ask for? Lenders have no qualms in disbursing large amounts of loan as it's easy to recover the loan if required.
    

1. Long tenure

   In the case of secured loans, borrowers have the advantage of the time to repay the loan amount. The repayment period is often longer.
    

1. Simpler terms

   Not much of a hassle to get a secured loan. It's easy to get it approved as the loan is always backed by collateral. Your credit rating may not be perfect but still you will get a loan, albeit at a higher rate of interest.
    

1. Low EMI

   The loan tenure being longer, the EMI becomes less. Beneficial for those who cannot afford to pay high EMIs.
    

Key considerations before applying for a secured finance

 

1. Insurance

   When applying for a secured loan, ensure that the collateral is insured. Assume you own a car whose value depreciates each year. After receiving funds for it, your car is involved in an accident, causing irreparable damage. You also default on your loan at the same time. Your lender will not be able to recoup its losses in this case because the pledged property is not in a condition to be auctioned off. However, if the car has insurance with a return to invoice add-on, the lender can rest assured of their payment to some extent.
    

2. Property papers

   Make sure the asset you want to use as collateral has a clear ownership document. If you are collateralizing your vehicle, for example, you must have a registration certificate. If the asset has multiple owners, especially if it is real estate, obtain NOC signatures from each owner before submitting the application.
    

3. Time to maturity

   This concept comes into play if you use your investment as collateral in a secure loan. Let's start with an example. Assume you own a bond with a 12% coupon rate and a 10-year maturity period. Two years remain until maturity. You applied for a loan with a 5-year repayment period and used this investment as collateral. When your investment matures after two years, you receive the amount in your account, and after a few months, you default on a loan. As the investment matures and is credited to your account, your lender will be unable to recover its losses. As a result, the time remaining until maturity is an important factor in loan approval.
    

Summary

To sum it up, if you’re already struggling to pay your existing debts, never go for secured loans. You may end up losing what you have. But if you are a good borrower with a high credit score or want a higher score, secured loans are for you!
 
Disclaimer: This post was first published on 23rd April 2018 and has been updated for the latest information, freshness and accuracy.