How Does Secured Debt Work? What You Need to Know

Secured debt is a loan backed by collateral. You pledge property like a house or car. If you stop paying, the lender can take it.

Lenders face less risk with secured loans. They often approve borrowers with lower credit scores. Interest rates are typically lower than unsecured debt.

But you face a real risk. Fall behind on payments and you lose your property. In bankruptcy, secured debt gets special treatment. You must decide whether to keep the property or surrender it.

What Is Secured Debt?

Secured debt is money you owe backed by specific property. The property secures the loan. Common examples include:

• Home mortgages
• Home equity lines of credit
• Auto loans
• Secured credit cards

Secured Debts and Collateral

Collateral is valuable property that backs your loan. You give the lender rights to this property. If you don’t pay as agreed, they take it back.

Two main types of property exist: real and personal.

🏠 Real property includes your home and land. Mortgage loans use real property as collateral. You borrow from the bank to buy the house.

If you don’t repay the mortgage, the lender reclaims it. They use a process called foreclosure. Breaking mortgage terms like insurance requirements also triggers this process.

🚘 Personal property includes cars, clothes, and household goods. Cars are the most common personal property used as collateral.

The car secures the loan. If you miss car loan payments, the bank reclaims it. They use a process called repossession.

How Secured Debt Works

You take out a loan backed by something valuable. You sign a loan agreement. The agreement says the lender can take your property if you default.

The lender gets a legal right called a lien. The lien stays until you pay the debt in full. Fall behind and the lender makes a creditor’s claim.

That claim leads to repossession or foreclosure. Sometimes lenders go to court. They get a judgment confirming their right to take the property.

🏛️ Tax obligations work similarly. The government places liens on your property until you pay.

With secured debt, risk ties directly to pledged property. Don’t pay and you lose it. That’s why interest rates are lower than unsecured loans. But you risk losing your assets.

Secured Credit Cards

Secured credit cards mix features of both debt types. You pay a security deposit to open the account. Your deposit becomes your credit limit.

You can use these cards anywhere credit cards are accepted. But they work differently when you default. The lender can’t take what you purchased. They take your security deposit instead.

Secured credit cards help you establish or rebuild credit. Your credit rating matters less to lenders. They get paid from your deposit no matter what.

Want to build credit without a deposit? Our partner Kikoff offers credit building accounts that report to all three bureaus.

Secured vs. Unsecured Debts: What’s the Difference?

The main difference is whether property backs the loan.

Secured debts have collateral backing them. Unsecured debt has no collateral. Common unsecured debts include:

• Credit cards
• Personal loans
• Medical bills
• Lines of credit
• Student loans

You can’t lose property with unsecured debt. A lender can’t revoke your education if you default on student loans. They can’t take back your medical treatment if you don’t pay bills.

Unsecured debts are riskier for lenders. You typically need good credit to get favorable rates. These loans can be harder to obtain.

Secured loans offer advantages that unsecured loans don’t.

Benefits of Secured Loans

Two main benefits exist with secured loans.

Lower interest rates: Collateral reduces lender risk. They offer lower rates than unsecured loans. Your credit score matters less than with unsecured options.

Lenders still check your credit report. But they focus more on the collateral value.

Easier credit approval: Collateral makes qualification easier. You can get approved even with imperfect credit history. You might pay higher rates than someone with excellent credit. But approval comes easier than unsecured loans.

What To Do if You’re Struggling To Repay a Secured Loan

Falling behind on secured loans creates stress. Your property is at risk. Taking action early gives you more options. You can avoid repossession or foreclosure.

Here are steps you can take:

Contact Your Lender Right Away

Tell your lender about your situation immediately. Many lenders offer hardship programs. They can temporarily lower payments or reduce interest rates. Some allow you to skip a payment.

These arrangements help you stay current. You protect your collateral while getting back on track.

Ask About Loan Modification

Long-term financial challenges need different solutions. You may qualify for a loan modification. The lender changes your agreement terms.

They might extend your repayment period. They could reduce your interest rate. These changes make monthly payments more manageable.

Consider Refinancing

Good credit and property value help you refinance. A new loan with better terms lowers your payment. Interest rates might drop too.

Refinancing works best before you fall too far behind. Act quickly to qualify.

Explore Selling the Property

Keeping the collateral might not be realistic. Selling it voluntarily helps you avoid extra costs. You also protect your credit from repossession damage.

You might sell for enough to pay off the loan. Even a partial payoff is better than losing the property.

Get Professional Guidance

Not sure which path to take? Talk to a nonprofit credit counselor. Or consult with a bankruptcy attorney.

They help you understand your rights. They explain the lender’s options. They identify steps to protect your property and finances.

If bankruptcy might be your best option, you can speak with a bankruptcy attorney for free to discuss whether Chapter 7 or Chapter 13 makes sense.

Should I Get a Secured Loan for Debt Consolidation?

High-interest credit card balances can overwhelm you. Some homeowners use secured loans to consolidate debt. A home equity line of credit (HELOC) is one option.

You combine multiple debts into one lower-interest payment. You save money on interest. Repayment becomes more manageable.

But important risks exist.

A HELOC is secured by your home. You need equity in your property. Your home must be worth more than your mortgage. The monthly payment must fit your budget.

You use HELOC funds to pay off credit cards. Then you focus on repaying the HELOC. Interest rates are typically much lower.

🚨 The main caution: don’t run up new credit card balances. After consolidating, avoid taking on new debt. New balances make it hard to keep up with payments.

The loan ties to your home. Miss payments and you risk losing your property. Weigh the benefits against this serious risk.

What Happens to Secured Debt in a Chapter 7 Bankruptcy?

Filing Chapter 7 bankruptcy erases your personal responsibility. You don’t have to pay the secured loan personally. But it doesn’t erase the lender’s rights to collateral.

You must decide whether to keep the property or surrender it.

If You Want to Keep the Property

You must keep making payments during and after bankruptcy. Car loans are the most common example.

In Chapter 7, you must be current on payments. Most lenders won’t let you reaffirm the loan if you’re behind. Reaffirming means you agree to keep paying and keep the property.

If You Want to Give the Property Back

Maybe the loan became too expensive. Perhaps the property no longer works for you. You can choose to surrender it to the lender.

The lender sells the property. Any remaining balance gets wiped out in bankruptcy. You walk away from the loan without leftover debt.

You tell the court and lender your choice. You use a required bankruptcy form called the Statement of Intentions. Your plan becomes clear to everyone involved.

Chapter 13 bankruptcy handles secured debt differently. It gives you more time to catch up on missed payments. You can read more in our article on Chapter 13 bankruptcy.