Fixed Income Tutorials
- Fixed Income
- Bond Pricing
- Yield Curve
- Convexity of a Bond
- Debt Covenants
- Negative Covenants (Restrictive)
- Credit Analysis
- Credit Analyst Career
- Credit Analyst Interview Questions and Answers
- Credit Rating Process
- Asset Backed Securities
- ABS and MBS Index
- Loss Given Default â€“ LGD
- Secured Loans
- Unsecured Loans
- Secured vs Unsecured Loan
- Subordinated Debt
- Subordination Debt
- Payment in Kind Bond
- Promissory Notes
- Sinking Fund
- Junior Tranche
- Fallen Angel
- Bills of Exchange vs Promissory Note
- Bonds vs Debentures
- Bills of Exchange
- Bond Equivalent Yield Formula
- Equity Research vs Credit Research
- Books on Bonds Market
- Treasury Management Book
- Fixed Income Books
- Credit Research Books
What is Secured Loan?
As you already know, a secured loan is a loan that is backed by an asset or equipment. The asset is called collateral. This collateral is needed because the amount of loan in the case of secured loan is much higher. This collateral helps the lender remain secured during the process of receiving the loan amount. And that’s why it is called the secured loan.
A secured loan is backed by an asset. That’s why the lender has no worries. Even the amount is huge. As a result, the lender accepts an interest rate that is much lower than the unsecured loan.
Let’s take an example to illustrate this.
Example of secured loan
Let’s say that you want to take a house. So, you go out and contact a bank and ask for a housing loan. The bank says that they will give you the housing loan without any issue, but there’s only one condition. The condition is you need to keep the house as collateral to the bank until the loan amount and the interest charges are paid off in full. Bank also says that as you’re accepting their offer, they will also offer you a reduced interest rate that is much lower than an unsecured loan.
You happily agree and go for the housing loan and buy your dream house. This is how secured loan works.
What happens when the borrower of the secured loans defaults?
Let’s take another example to illustrate the status of the lender and the borrower if the borrower defaults.
- Let’s say that Mr. M has taken a housing loan from a bank. Things are going pretty good. Mr. M has got the house and paying off the loan in installments.
- Now, suddenly Mr. M gets laid off from his job and feels overwhelmed since now Mr. M doesn’t have any money to pay off the housing loan.
- In this situation, a bank will come to Mr. M and declare that they will possess his house. Bank does a valuation of the house and notices that the market value of a house isn’t enough to pay off the entire loan.
- So bank sells off the house and asks Mr. M to pay the difference.
From this, we can see the status of the lender and the borrower. In the case of secured loan, the lender is always at a better position than the borrower because they know that they can sell off the asset if the borrower defaults and at the same time they can claim the difference from the borrower if the market value of the asset isn’t enough to pay off the loan.
Important features of secured loan
Let’s look at the most important characteristics of secured loans –
- Asset backing: In every secured loan, the lender gets a backing of the asset. As a result, a loan from the lender side becomes secured.
- Lower interest rate: Since the loan is backed by the asset, the interest rate is much lower. As a result, the borrower pays less interest in the case of a secured loan than in the case of an unsecured loan.
- Huge amount: Secured loans are usually huge in amount. If the amount is not huge, why the borrower would be ready to share his property for the collateral? In the case of a secured loan, the amount of loan that’s why is much larger than an unsecured loan.
- Loan against the same thing the buyers are buying: Usually, the borrowers of secured loans are those who are also buying a property. And in the most case like housing loans, car loans, auto loans, the buyers let the lender use the house, the car, the auto respectively for securing the secured loans. This arrangement helps the buyers buy the asset/equipment easily and at the end of the day, the lender also remains secured.
- Secured business loan: In the case of business, the conditions of the secured loan are bit different. Since the businesses have more money to pay off, the loan amount is usually higher than housing loan, car loan. And a business lets the bank/financial institution use one of their assets/machinery/furniture/raw materials as collaterals for the loans.
This has been a guide to Secured Loans, examples, features of secured loans and what happens when a borrower defaults. You may also learn more about fixed income from the following suggested articles –