For both individuals and companies, obtaining finance is practically a fact of life. At some point, a loan must be taken out in order to fund the purchase of a house or the expansion of a company. However, there is one problem that both individuals and companies often encounter; a bad credit rating can be an obstacle when applying for finance.
Many types of loans will demand applicants to have a good credit rating with a clean history behind it. However, a squeaky-clean credit record is not easy to obtain, and given the current economic circumstances, is increasingly out of reach for many. As such, alternatives are necessary.
One such alternative is secured loans. This type of loan allows individuals and companies to obtain finance despite having bad credit. In this article, we will discuss secured loans, how they work, and whether they are a good idea for you. Let’s get started.
What is a secured loan?
A secured loan is a type of loan that requires the borrower to use some physical assets as collateral. These assets must be of similar value to the loan’s value, and will determine whether an application succeeds or fails. Unlike other types of loans, such as unsecured loans, these assets are often the most important part of a secured loan application. While the borrower’s income, financial history, and credit rating still hold some sway, they are not nearly as important for secured loans.
As collateral is the more important factor for a secured loan application, this form of finance is much more accessible for those with bad credit. However, this accessibility comes at a cost. Lenders will place a lien on any assets used as collateral. Essentially, this means that your lender is entitled to seize assets in the event you default. These assets will then be sold off to recover the remaining value of the loan. Naturally, this poses a much larger risk than other types of loan, potentially making it untenable for borrowers with rocky finances.
Also Read: Are Small Business Loans Secured or Unsecured?
Obtaining a secured loan with bad credit
Although secured loans are more accessible to borrowers with bad credit than other forms of finance, it isn’t quite so easy to settle on a particular loan. There is a wide variety of secured loans to choose from, each being suited to some scenarios more than others. Let’s discuss a few.
Personal loans
Personal loans are a type of secured loan that has a wide range of applications. They can be used to finance home renovations, vehicle purchases, and for many other personal uses. Additionally, although they fall under the umbrella of secured loans, personal loans do not always require the borrower to provide collateral assets. This is highly dependent on the lender, and will hinge on the credit rating and income of the borrower. That said, personal loans are commonly obtained by borrowers with a bad credit rating, and can even be acquired without the use of collateral.
However, borrowers looking to obtain a personal loan without collateral should pay close attention to the interest rates and other fees of their chosen loan. While the lack of collateral does reduce risk, it often increases the overall cost of the loan through significant interest rates and potentially other hidden fees, such as early repayment fees, administrative fees, and so on.
Also Read: Unsecured vs. Secured Loans
Payday loans
Payday loans also typically fall under the umbrella of secured loans. Often requiring the borrower to provide some form of collateral. For many borrowers, payday loans are seen as a viable alternative to personal loans, in the event the latter cannot be obtained. However, this is not the best way to look at payday loans.
Payday loans almost always come with exorbitant interest rates, the cheapest being to the tune of several hundred percent. This sheer expensiveness pretty much rules out payday loans as a sensible choice, offering very short-term gain at long-term expense. Payday loans also have a short repayment term. They require the borrower to repay what they owe in full and in a short space of time. Payday loans do allow borrowers to roll over the loan for another month or so. This is certainly more of a hindrance than a help. This exposes the borrower to exorbitant interest rates for a longer period of time, which can rack up fast. Before long, payday loans can cause borrowers serious financial problems and possibly even lead to bankruptcy. For borrowers with bad credit, this problem can be even worse, since bad credit typically means higher interest rates. As such, they are best avoided.
Home loans
One of the staples of the secured loan categories, home loans allow the borrower to take out large loans secured against their home. The more valuable your property, the larger the loan you can obtain. There are also multiple types of home loans available. Such as HELOCs or cash-out refinance, which offer some flexibility in how you use your home loan. A HELOC, for example, allows borrowers to use the equity in their home as a line of credit. This line of credit can be tapped into at the borrower’s leisure, being used to raise finance as and when necessary.
Home loans are also an effective finance solution for borrowers with bad credit. The determining factor in the success of an application is the value of the home used as collateral. Credit rating and other factors largely fall by the wayside. Though certainly less important, bad credit can impact the overall cost of a home loan. Borrowers with bad credit will usually have higher interest rates to pay. However, compared to the disadvantages of other loans, such as the egregious cost of payday loans, this is not a dealbreaker.
Wrapping up
All in all, secured loans are an excellent choice for borrowers with bad credit. They offer a financial solution that is perfectly accessible to both individuals and companies with bad credit. Provided they have assets to use as collateral. However, there are multiple types of secured loan, with some being much better for borrowers with bad credit than others. As such, you should always do your research and consider how your finance options work with your situation.