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What is a Secured Loan? Your Complete Guide

In life's twists and turns, we often need a financial crutch, and that's where a loan comes in handy. However, not all loans are the same. In India, you have two main choices: secured and unsecured. In this article, let's explore secured loans together, and take a look at their types, features, and their pros and cons.

Secured Loan vs. Unsecured Loan: What's the Difference?

A secured loan is like a handshake with a guarantee. You borrow money from a lender, but in exchange, you offer up an asset (your house, car, jewellery, etc.) as collateral. Think of it as a promise: if you don't repay the loan, the lender gets to keep your precious collateral. This security reduces the lender's risk, allowing them to offer you lower interest rates and higher loan amounts compared to unsecured loans.

Unsecured loans, on the other hand, is like you borrowing money without keeping anything as a guarantee, lender evaluates you based on your profile & track record of repayment. They require no collateral but come with potentially higher interest rates and stricter eligibility requirements.

Types of Secured Loans and Their Interest Rates:

The Indian loan market offers a variety of secured loans, catering to specific needs or based on type of security kept as collateral. Let’s take a look at the most popular options, along with their indicative interest rates:

Loan Against Property (LAP): 9-14% - A Loan Against Property lets you use your house, land, or commercial property as collateral for small or large sums of money. The funds are available for any expenses you may have. In event of failure of repayment, the pledged property may be repossessed by lender.

Home Loan: 7-9% - When you take out a home loan, the house you buy acts as security for the loan. This means that if you don't repay the loan, the lender can repossess the house and sell it to recoup their losses. Key difference between LAP & Home loan is, in a home loan the money borrowed can be only used towards purchase or construction of the home.

Business Loan: 10-18% - A secured business loan helps you to raise funds for various needs like working capital requirements or long-term capital expenditure by pledging business assets or property. In a secured business loan various types of securities can be pledged as collateral. Example: Property, Equipment, Inventory, Accounts receivable, investments, etc.

Loan Against Securities: 9-13% - A loan against securities helps you to raise funds by pledging your bonds, mutual funds, or shares as collateral.

Car Loan: 7-10% - A car loan enables you to purchase a new car where the loan is backed by the car itself.

Gold Loan: 8-18% - Historically gold has been used as a security for secured loans. Gold jewellery, bars, coins or any other form maybe pledged for a secured loan.

Note: The interest rates mentioned above are for reference purpose only.

Read the article “Pledging Investments For Loans: How To Choose The Right Loan?” to understand each of these in detail.

Features of Secured Loans:

Lower Interest Rates: The interest rates of a loan are usually directly proportional to the credit risk associated with it and hence, the Collateral sweetens the deal for lenders, translating into lower interest rates for you.

Higher Loan Amounts: Secured loans with their built-in safety net, allow the lender to lend you larger sums as per the Loan to Value ratio associated with the collateral. (The loan-to-value ratio (LTV) compares the loan amount to the value of the pledged collateral. The higher the ratio, the bigger the loan relative to the value of the collateral you're pledging as security.)

Flexible Repayment Terms: The repayment of loan, when it is backed by a collateral can be spread out over longer tenures, making your EMI more manageable. Some secured loans may also be availed as an overdraft facility with very flexible withdrawal and repayment terms.

Faster Loan Approval: With the security of collateral, lenders might be quicker to approve your loan application. However, this may not be true for all secured loans, as some of the secured loans like loans against property involve a large amount of paperwork and legal documentation. While other secured loans such as loans against mutual funds can be processed in no time due to seamless digital facilities.

Documents Required for Secured Loans:

Each loan type has its list of documents, but some of the common requirements include:

1. KYC documents (PAN card, Aadhaar card)
2. Income proof (salary slips, ITRs)
3. Asset-related documents (property papers, car registration)
4. Bank statements

Pros of Secured Loans:

1. Lower interest rates, saving you money in the long run.
2. Access to higher loan amounts for bigger goals.
3. Flexible repayment options for a comfortable repayment experience.
4. Potentially faster loan approvals due to reduced risk for lenders.

Cons of Secured Loans:

1. Risk of losing your collateral if you default on the loan.
2. Stricter eligibility criteria compared to unsecured loans.
3. May involve more paperwork due to property valuation and verification.

Other things to consider while availing a secured loan:

1. Your lender may give you an option to choose either from a fixed rate of interest or a variable one.
2. Repayment towards a secured loan may help improve your credit score.
3. The interest paid on the loan could be tax deductible.
4. The asset being pledged needs to be solely owned by the person applying for the loan.

How to apply?

1. Visit the bank or NBFC’s office or website.
2. Provide necessary information and KYC documents
3. Submit the income documents (if required) and the collateral documents
4. Many banks, NBFCs & fintech’s also facilitate the loan process via a 100% digital application journey.

If required, provide any other extra paperwork/documentation required by the lending institution. The loan will be disbursed soon if everything is in place.

Conclusion

Secured loans offer lower interest rates and higher loan amounts with collateral, making them powerful financial tools. However, the risk of collateral loss requires cautious consideration. Thorough research, responsible borrowing, and assessing repayment capacity are essential while availing a secured loan.