When most people borrow a loan, they have every intention of paying it back. With some loans, however, the lender requires more assurance of recouping their costs if a borrower defaults. In these cases, the borrower will pledge an asset as collateral to âsecureâ the loan. Borrowing with collateral not only assures a lender theyâll get their money back, but it can allow borrowers with lower credit scores to qualify for loans â sometimes with a lower interest rate.
Letâs take a close-up look at how secured loans work. Then, weâll consider their pros and cons.
A secured loan, or collateral loan, is typically (but not always) a lump-sum loan backed by a valuable asset, such as a vehicle, real estate or money account. This collateral acts as a guarantee that the lender will be repaid throughout the agreed-upon repayment period.
Loans that donât require any collateral, like most personal loans, are known as âunsecuredâ loans. A borrowerâs eligibility for an unsecured loan is determined primarily based on a lenderâs evaluation of the borrowerâs credit score and debt-to-income ratio (DTI).
Real estate secured loans allow you to use your property as collateral to obtain financing. These loans can provide access to funds at competitive interest rates since the lender has your home or real estate as security. In this comprehensive guide, we’ll explain everything you need to know about real estate secured loans.
What is a Real Estate Secured Loan?
A real estate secured loan is a loan that uses your real estate property as collateral. The property acts as security for the lender – if you default on the loan the lender can seize the home through foreclosure to recover their losses.
Common types of real estate secured loans include
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Mortgages – The most common type of real estate secured loan, used to purchase a home. The home acts as collateral.
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Home equity loans – Allow you to borrow against the equity in your home. Your home is used as security.
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Home equity lines of credit (HELOCs) – Revolving credit lines with your home as collateral. You can draw funds as needed up to a set limit.
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Reverse mortgages – Specialty mortgages that allow seniors to tap home equity. The loan must be repaid when the homeowner dies, sells, or moves out.
The key benefit of a real estate secured loan is that it allows you to leverage your property to access funds at competitive rates. Lenders view these loans as less risky since they can recover losses through selling your home if you default.
How Do Real Estate Secured Loans Work?
With a real estate secured loan, your property acts as collateral for the debt. Here’s a quick overview of how they work:
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You apply and go through underwriting – The lender will evaluate your income, credit score, debt levels and property value to determine loan eligibility and terms.
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If approved, you receive loan funds – After approval, you’ll get the loan amount (less any fees) to use as needed. With mortgages, funds go towards your home purchase.
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You make monthly payments – Real estate secured loans involve regular monthly payments to repay principal and interest over a set period. Terms often range from 10-30 years.
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The property acts as collateral – Your home or real estate is pledged as security for repayment. If you default, the lender can foreclose and take ownership of the property.
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Loan is satisfied after repayment – Once you repay the full loan amount as agreed, the debt is settled and the lien on your property is released.
Common Uses for Real Estate Secured Loans
There are many possible uses for real estate secured loan funds. Here are some of the most common:
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Home purchases – The primary use of mortgages is to finance the purchase of a home. The home then acts as collateral.
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Debt consolidation – Borrowers can roll high-interest debts like credit cards into real estate loans at lower rates. Helps simplify finances.
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Home improvements – Funds can be used for remodeling projects, upgrades, additions, and repairs. Helps improve property value.
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Major expenses – Big one-time costs like medical bills, college tuition, or starting a business can be financed through real estate loans.
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Investing – Borrowers can tap home equity to obtain investment capital for purchasing rental properties, stocks, or other assets.
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Everyday costs – Some borrowers use funds to cover regular living expenses in retirement or between jobs. Not ideal, but an option.
The flexibility of real estate secured loan funds allows you to put the money towards nearly any purpose. Just keep monthly payments affordable based on your budget.
What are the Benefits of Real Estate Secured Loans?
Real estate secured loans offer several advantages that make them a popular financing option:
Lower Rates – Secured loans offer lower interest rates, often 2-5% less than unsecured options like personal loans or credit cards. This can save substantially on interest costs over the loan term.
Tax Benefits – With home loans like mortgages and HELOCs, the interest paid is usually tax deductible, providing savings each year. Always consult a tax professional to understand deductions.
No Restrictions on Use – Unlike purchase loans, home equity loans/lines place no restrictions on how you use the funds. Use them as you see fit.
Consolidate Debt – Rolling high-rate debts into a lower real estate loan rate can simplify finances and potentially lower monthly payments.
Build Credit – Handled responsibly, real estate loans allow you to demonstrate on-time payments and creditworthiness. This helps build your credit profile over time.
Access Equity – Tap into your build-up home equity without having to sell. Useful for major expenses or investing capital.
For eligible borrowers, real estate secured loans offer competitive rates and flexible access to funds. Make sure to only borrow what you can reasonably afford to repay.
What are the Risks of Real Estate Secured Loans?
While real estate secured loans offer benefits, they also come with some inherent risks to consider:
Collateral Loss – Defaulting on the loan risks foreclosure and loss of your property. This makes repayment essential.
Interest Costs – Interest expenses accumulate, especially on larger loans. Make sure you budget appropriately.
Prepayment Penalties – Some loans impose fees if you repay early. Factor this into any refinancing or early payoff plans.
Reduced Equity – As you borrow against your property, you reduce the equity available for future loans.
Credit Damage – Missed payments can negatively impact your credit scores and ability to borrow. Keep payments current.
Rate Fluctuations – Variable rate loans can see payments rise if interest rates trend upward. Make sure you can handle potential increases.
Fees – Costs like origination fees, closing costs, and appraisal fees factor into the total expense.
The bottom line is that while real estate secured loans can be useful, borrowers must repay them responsibly to avoid losing their property. Only borrow what you can reasonably manage.
What Credit Score is Needed for a Real Estate Secured Loan?
The minimum credit score needed for real estate secured loans will vary by lender. Here are some general credit score guidelines:
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Mortgages – Most lenders look for at least a 620 FICO score, but scores of 700+ are ideal for the best rates/terms. Some specialized mortgage lenders may allow scores as low as 580.
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Home Equity Loans – Minimum scores are often around 620, but 660+ is better. May be able to qualify with a 580 FICO.
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HELOCs – HELOC lenders often want to see at least a 660 credit score. Some may accept 640+, but the rates won’t be favorable.
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Reverse Mortgages – These specialized mortgages designed for seniors generally require a credit score of at least 620-640 to qualify.
The higher your credit score, the better mortgage and home equity loan offers you can qualify for. Take time to boost your score before applying. Pay all bills on time, lower debt burdens, and correct any errors on your credit reports. A score of 700+ should ensure you get competitive real estate loan rates.
What Debt-to-Income Ratio is Recommended?
Lenders also look closely at your debt-to-income (DTI) ratio when approving real estate secured loans. Your DTI compares your total monthly debt payments to your gross monthly income.
Here are typical DTI requirements:
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Mortgages – Most lenders want your DTI below 43%. Ideal DTI is 36% or less for the best deals.
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Home Equity Loans – Lenders look for DTI of 50% or less. The lower your DTI, the better.
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HELOCs – Expect a maximum DTI of 45-50% to qualify.
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Reverse Mortgages – DTI ratios are not a factor with reverse mortgages. However, you still need sufficient income to pay property taxes, insurance, HOA fees, and maintenance costs.
Work to pay down existing debts like credit cards, auto loans, and student loans to get your DTI as low as possible before applying. This will maximize your borrowing power and loan options.
How Much Can You Borrow with a Real Estate Secured Loan?
Loan amounts with real estate secured loans depend on several factors:
Loan-to-Value (LTV) Ratio – The ratio comparing the loan amount to the property value. Conventional mortgages require 80% LTV or less. Home equity loans range from 70-85% LTV depending on the lender.
Home Value – The appraised fair market value of your home or property. Higher values allow larger loan amounts.
Available Equity – The equity built up in your home based on the current market value minus existing mortgage debt. More equity enables larger loans.
Credit Score/DTI – As discussed above, your credit and debt ratios impact the loan size you qualify for.
Loan Type – Each real estate loan product (mortgages, home equity,
What Can You Use As Collateral?
Any form of collateral should carry a value thatâs equal to or more than the requested loan amount. Lenders also prefer assets that they can easily collect and sell in the event of a default. Assets typically used as collateral include:
- Real estate (home equity)
- Vehicles
- Machinery or equipment
- Liquid assets like stocks, investments or savings accounts
- Insurance policies like life insurance
- Other collectibles or valuables
See What You Qualify For
Secured loans are generally less risky for lenders to approve. Therefore, as already noted, interest rates can often be lower than with unsecured loans. Getting a loan with collateral can also help borrowers with lower credit scores qualify for financing.
When taking out a secured loan, itâs important to think about the possession youâll choose to be your collateral and what can happen if you default on your loan.
Real Estate Secured Loans Explained │ REI with Ryan
FAQ
What is a secured loan in real estate?
Is it possible to have a secured real estate loan without a mortgage through?
How hard is it to get a secured loan?
What does lack of real estate secured loan mean?
What is a secured loan?
A secured loan is a loan that is secured by a valuable asset. Examples include real estate, cash accounts, or an automobile. In many cases, the loan is secured by the underlying asset being financed, such as a home or vehicle. Alternatively, borrowers may be able to pledge other collateral like investments or valuable collectibles.
Should you buy a home with a secured loan?
It depends on what you’re using the loan for. If you’re buying a home, a mortgage is definitely the way to go. “Secured loans are safer loans for the lender, so they’re less expensive for the customer,” says Craig Garcia, president of Capital Partners Mortgage.
What collateral is accepted for a secured loan?
Secured loans accept various types of collateral such as real estate properties, vehicles, savings accounts, and valuable personal assets like jewelry or art. The specific collateral accepted may depend on the lender and loan type.
What should I do if I need to get a secured loan?
If you need to get a secured loan, contact your lender immediately and review your budget to prioritize payments to avoid losing your collateral. While mortgages and auto loans are common examples, there are various other financing options that may require collateral.