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How a secured loan works



Banks are more willing to give borrowers loans with collateral, the kind where the lender has a guarantee of repayment. If the person stops paying, the bank will be able to collect the money in another way. This does not require a lawsuit or intervention by other companies. A common type of secured loan is a secured loan: money is given against a pledge of some property.

What is a secured loan?

This is a type of loan in which the borrower receives money from the bank and in return provides his property as collateral. This remains the property of the person, and he can use it in full, but there are some restrictions. The borrower will not be able to sell or donate something that is pledged without the lender’s permission. It is also not possible to change the collateral at the request of the borrower – only if the bank agrees to this. Encumbrances are removed when a person pays off the loan in full.

What does being in pledge mean

This means that the subject acts as collateral for the loan and gives the bank a guarantee of repayment. That is, if the borrower stops paying, the lender will have the right to seize the pledged property. The apartment, car, or equipment that has become collateral will become the property of the bank and will be sold at auction. The bank will use the proceeds to cover the losses due to the defaulted funds. But if you are going to pay back the loan and are confident in your abilities, you should not be afraid of such an outcome. It will occur only if you are noticeably overdue or in arrears. Then the bank will understand that there is no other way to get the money.

Why do people take collateral loans?

Some types of credit are only secured by collateral, such as a car loan or a mortgage. In these cases, the collateral is what the person went to the lender for. In other cases, people choose to take out loans secured by collateral to lower the interest rate or to improve the terms. Secured loans are usually more advantageous than unsecured loans. They can be given at a lower interest rate and for a larger amount. And for some types of borrowers, collateral is the only chance they have of getting a loan. This is the case for people with a bad credit history, whom banks are suspicious of.

Pros and cons of a secured loan for the borrower

Pluses

  • Better terms
  • Higher chance of approval
  • Higher amount the bank will approve.
  • No guarantors or third parties
  • Not so important credit history
  • Lower income requirements

minuses

  • The property cannot be sold or donated
  • Subject of pledge can not be changed without the permission of the bank
  • More complicated
  • More difficult to refinance
  • In case of nonpayment the bank may foreclose the collateral

Pluses and minuses for the creditor

Pluses

  • Higher responsibility of the borrower
  • Lower risk of non-payment
  • There is a protection against losing money

minuses

  • More complicated registration
  • Verification of property and the borrower is required
  • Possible problems with the sale of the property

What should be the subject of pledge

It is very important for the bank to protect itself against losing money, and that is why you need a pledge. Therefore, the bank has certain requirements. Before the loan is granted, the bank evaluates the property offered and determines whether it makes sense to agree to such terms. The subject of pledge must:

  • be liquid, i.e. easily sellable at market price, be in demand;
  • not be under any encumbrances, such as arrest;
  • be owned by the borrower or co-borrowers;
  • be free of any claims from third parties, such as heirs or other banks;
  • Be 30% or more more expensive than the loan.

According to these criteria, expensive, but illiquid property will be bad collateral. But less expensive, but in demand will do.

Requirements for the borrower

They are usually lower than for unsecured loans. However, the bank needs to know that his client can return the money, so it evaluates the reliability and solvency of the borrower. Expensive property ownership, additional income and other factors will be a plus.

Algorithm of registration of a collateral loan

  • A person chooses a property and a bank, collects documents and applies for a loan.
  • The bank accepts the application, assesses the solvency of the borrower and compliance with the requirements. The period of verification is from one day to two weeks.
  • The lender makes a decision and informs the person about it. Approval lasts a certain period: during this time you need to show the bank the pledged property and wait for the appraisal.
  • The bank evaluates the collateral and negotiates terms with the borrower. This lasts up to two weeks, depending on the type of loan. It takes the longest time to execute a mortgage.
  • The parties sign an agreement.
  • The client receives the money from the bank.

What documents are needed for the application

A passport and a document of title that confirms that the person owns or will own the property is sufficient. This can be a certificate of privatization or the right to inheritance, a contract of gift or sale. If you don’t own the property yet, you don’t need to provide documents for it. But you might need to specify what it is you want to buy. If you have a mortgage or other large loan, banks may ask for a statement of income and other documents showing your ability to pay.

What to do if you can’t pay

Failure to pay your secured loan threatens to lose your assets, but that doesn’t mean you should panic at the first default. Banks will only foreclose on your collateral if they see that there is no other way to fix the problem. At first, it is more advantageous for them to negotiate with the borrower and resolve the issue without foreclosure. So if you have financial difficulties contact the bank, explain the situation and ask to change the terms or to postpone. There is a high probability that they will meet you halfway: it is always easier to come to an agreement than to go to court.

Nevertheless, the responsibility of taking out a collateral loan is particularly important. Think carefully and only take out a loan like this if you really need it. And try to pay back your existing loans on time, even if they are unsecured.