Secured Personal Loan: What You Need to Know

Applying for secured loans can feel intimidating, especially if you aren’t sure what lenders are looking for. Once you know how to qualify, it’s easier to prepare and show you’re a reliable borrower. This can help you get your loan approved and qualify for better terms.

Credit score

When applying for secured loans, lenders want to know how likely you are to pay back the funds. One of the ways they do this is by looking at your credit score, a prediction of how likely you are to pay the money back on time. This score is calculated based on several factors, like how much debt you have, what different types of debt you have, and how you’ve paid off debt in the past.

For a lender, a good credit score shows you’re less of a risk, and therefore, they’re more willing to offer better loan terms. On the other hand, if you have a low score, the lender might charge a higher interest rate to make up for the perceived increase in risk, or they might not be able to approve your loan at all if they require a minimum credit score.

One way to work around a low or non-existent credit score is to add a cosigner to your loan application. A cosigner agrees to take responsibility for your debt if you’re unable to pay. This makes lenders feel more secure, as someone with a higher credit score or a more reliable source of income is backing you up. As a result, you may be able to obtain a lower interest rate or qualify for a secured loan that wouldn’t have been possible on your own.

Another option to improve your chances of getting a personal loan without a credit score: Use collateral to back your loan.

Collateral

Collateral is something of value that helps secure your loan. Many lenders, but not all, require the collateral’s value to be equal to, or higher than, the amount of money being loaned.

Collateral helps to reduce the risk for the lender, as you’re incentivized to pay back your loan on time to avoid losing your asset. In the worst case, even if you don’t pay back the lender, they feel confident that they can recover their money by selling your collateral.

Some of the most common types of secured loans and their collateral include:

A mortgage: Secured by your home or another property
Car loan: Secured by your car, motorcycle, or other vehicle
A life insurance loan: Secured by the cash value of your life insurance policy

In the case of a secured personal loan, the collateral can be a variety of different physical assets, such as a property, vehicle, or a savings account.

Income level

Because income isn’t included in your credit score, you’ll need to show how much you earn. Examples of the type of income you can include on your application are:

Employment income: Salary, hourly wages, and tips
Investment income: Dividends or interest from savings
Social assistance: Disability payments (but not unemployment benefits)
Child support: If you’re a single parent caring for children

Lenders may ask for pay stubs, bank statements, or tax returns to verify the information you provide. This is because many creditors are required by law to verify that you can afford to pay back your debt.

Debt-to-income ratio

Using your credit score and income level, lenders can then calculate your debt-to-income (DTI) ratio.This ratio helps them to determine how much of your monthly income goes towards paying debt.

For example, if your monthly gross income (the amount you receive before any deductions or taxes) is $3,000 and you spend $750 every month towards debt payments, then your DTI is 25%.

Important to note for the DTI ratio is that rent payments are also included as part of the monthly debts you need to pay. As a result, this percentage might be higher than you originally think.

In general, lenders prefer a DTI ratio of less than 35%. Some may also have a specific maximum DTI ratio they use as a threshold for approving personal loans.

The bottom line

To qualify for a secured personal loan, lenders assess your credit score, income level, DTI ratio, and collateral. If you’re trying to qualify for a loan, the best approach is to review your financial situation and try to reduce your expenses so you can pay off existing debts.

It’s possible to see a noticeable difference in your credit score with just six months of on-time payments, so it’s worth starting to form healthy financial habits as soon as possible. That way, if you do need to fill a cash shortfall or cover an unexpected expense, you’ll be in a much more favorable position and are more likely to be approved for a personal loan.