Secured Loans – The Pitfalls

For most of us, a secured loan will be either a car loan or a home mortgage. A secured loan means that there is something used as collateral so that if you default on your payment, the lender takes the collateral from you instead. In the case of a car or home loan, the collateral or security for the loan is the item you are buying.

This is why getting either of these loans has traditionally been so easy — if you had no credit or even bad credit, you could usually buy a house or a car. The difference your credit makes is in the interest rates you pay. That may not seem like a big deal until you multiply it out over the life of the loan and realize that you may pay two or three times the actual price once you add in the interest.

So, what are the pitfalls? Well, the obvious one is that if you bite off more than you can chew or if an emergency such as an illness or job loss makes it impossible for you to make your payments, you can suddenly be without transportation or homeless.

To make matters even worse, what if you are “upside down” in your car? This term means you owe more on the car than it’s worth. Maybe you took out a 5-year loan (something I recommend you never do), or maybe your purchased an extended warranty. What happens then? You may think that after your car has been repossessed, that’s the end of it. That isn’t necessarily true. If you owe $20,000 on a car that the dealer only gets $15,000 for when its sold, they will come after you for the difference. Which means, you will pay them $5,000 for a car you no longer own.

And what abut your house? If you bought the house while the housing market was going like gangbusters in California, you could have easily paid $500,000 for a house that in today’s market is only selling for $150,000. The mortgage holder is going to want the difference between what you owe and what they sell the home for. It’s unlikely you have $350,000 sitting around, or you wouldn’t have lost your home in the first place.

In both cases, a default will stay on your credit report for years, making it difficult — or expensive — to take out another loan in the future.

My advice? Make sure you know what you’re getting yourself into. Don’t enter into a loan for as much as the bank will give you. Make sure you have a contingency plan and an emergency fund in place. It’s best not to borrow, but if you have to, borrow the least amount you can. You can always upgrade later if your financial situation allows.

 

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