What risks do secured personal loans pose?
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UPDATED: Nov 26, 2012
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Secured personal loans pose several risks to borrowers including collateral repossession and lowered credit scores.
A secured personal loan is protected by a form of collateral, which often includes real estate, cars, boats, equipment or, in some cases, jewelry and other valuable items.
In the event that a borrower fails to make payments on a secured personal loan, the items are repossessed by the lender to accommodate for the defaulted loan’s cost. The repossessed item will be resold, usually at a lower price than it is worth, to pay for the defaulted loan.
The most predominant risk of having collateral linked to a secured personal loan is the possibility that an item can be taken away. Although linking a loan to a valuable piece of property enables the lender to offer a lower interest rate, it does threaten the valued item. Some borrowers offer up a primary residence or a necessary car for a needed loan. If those borrowers do not repay, they will lose the item, regardless of their need to keep it. This can force a struggling family to move out of a home or to use public transportation once their collateral is repossessed.
When items are used as collateral, defaulting borrowers can technically sell them to another person or company before their primary lender comes to repossess their collateral. But doing so is considered extremely illegal. Lending companies will be forced to seek legal action if their loan collateral is sold without their knowledge or consent.
Besides the illegality of selling securing items, doing so will destroy any remaining confidence between the borrower and lender and make any chances of reconciliation highly unlikely.
Lowered Credit Scores
Secured personal loans are usually offered to people who are denied an unsecured personal loan. While they offer a valuable method of building one’s credit, they can just as easily destroy one’s credit history.
When applying for money, secured or not, a lender will review a borrower’s credit score. If the history is poor, the lender will likely require the person to offer up items for added security.
Due to lower interest rates, the monthly payments for a secured personal loan will be lower than unsecured personal loans.
While repaying a secured loan might be easier than their unsecured counterparts, the entire lending process will still be tied to a borrower’s credit history. Some people might offer up their valuables as collateral and think that if worst-comes-to-worst, they will only lose their items. But further implications can also occur.
Although secured personal loans offer lenders security and ensured repayment, their required collateral does not keep a lender from harming one’s credit score. The three credit reporting agencies will be informed that a secured loan was forced into repossession if it is defaulted on. This will negatively affect one’s credit history and prevent low-interest lending for years to come.