There are two categories of loans and they are secured and unsecured loans. Unsecured loans are those that are not backed by collateral while secured loans are those that are backed by collateral. Collateral is an asset that is of the same or higher value than the amount of the loan and is used as security for the loan. This means that in the event that the borrower defaults, the security will be used to settle the loan.
Collateral can be any asset such as a house or any real estate property, car, jewellery or any valuables. Loans secured by property are also referred to as mortgages and they are common financial products that allow the borrower to use real estate as security. This type of credit facility gives the lender a higher level of security different from unsecured loans.
You can visit https://www.open.edu/ for more details about mortgages.
In this article, we will explore the key features of loans secured by property or real estate and their pros and cons.
What is a Loan Secured by Property?
A loan secured by property is one in which the borrower puts down real estate such as a home or land as collateral or security for the credit facility. The property stands as security and assured the lender that the borrower will not default in repayment and even if the borrower defaults, the value of the property can cover for the loan. The process of using the collateral to offset the loan is known as repossession or foreclosure.
Characteristics of Secured Loans
The following are the major characteristics of this category of credits:-
Requires Collateral
The major feature of this type of credit is the need for collateral. Apart from having a property to put down as collateral, the said property must be valuable enough or have adequate equity that matches or exceeds the loan sum. The equity of the property is calculated difference between the market value of the property and the outstanding amount on the mortgage or lien if there is one on the property.
Lower Interest Rates
Due to the fact that these credit facilities are backed by a tangible asset, they are considered low risk ventures by the lender. This therefore gives the lender the confidence to negotiate lower interest rates as opposed to what is obtained with unsecured credits.
Higher Borrowing Limits
Secured credit facilities usually have higher borrowing limit than their unsecured options. This therefore makes them more suitable for people who need substantial amounts for significant investments and projects such as debt consolidation or home renovation.
Longer Repayment Terms
These credit facilities usually come with longer repayment periods than unsecured ones. These repayment terms range from between 5 to 30 years. Longer repayment periods mean that monthly repayments will be lower. However, longer repayment periods can lead to higher interest paid over the lifetime of the loan.
Types of Loans Secured by Property
There are different types of loans that are secured by property and they are as follows:-
Mortgage
This is the most popular kind of secured loan and it is mainly used in buying a home or real estate. You can go here for more information on this. The repayment term for this credit facility is long; spanning a period of 15 to 30 years. The interest rate is also usually low and the mortgage can be adjustable rate, fixed rate or interest only.
Home Equity Loans
These types of credit facilities enable homeowners to borrow money against their property’s equity. It is usually a substantial sum that comes with a fixed schedule for repayment and interest rate. These types of loans are mostly used for college funds, medical bills or home renovation.
Home Equity Lines of Credit (HELOCs)
This is a revolving line of credit that is backed by the equity in a property. In this option, borrows are allowed to withdraw funds as they need up to a certain limit which makes it a flexible alternative for revolving expenses. The interest rates for HELOCs are typically variable.
Benefits of Secured Loans
Secured loans are not only a low risk venture for lenders but are also beneficial for borrowers. Find below some of those benefits:-
Lower Interest Rates
Due to the fact that the risk on the part of the lender is reduced, the interest rate in this option is typically lower than for unsecured loans.
Higher Loan Amounts
Borrowers can access substantial amount of money with secured credit facility and this is usually a critical factor for people who need large amounts of money to carry out capital projects.
Improved Credit Opportunities
When you successfully repay a secured loan, it can significantly improve your credit score. This potentially opens doors to opportunities for financing with better terms and rates in the future.
Tax Deductions
Interest paid on some types of secured loan may be tax-deductible; some of these include home equity loans and mortgages. This also offers additional benefits to the borrower.
Risks and Considerations for Secured Loans
As with everything in life that has advantages and disadvantages, secured loans also come with risks that must be considered before signing any loan agreement. It is recommended that you do your due diligence and weigh the pros and cons in order to know whether to proceed or not.
Below is a brief discussion of these risks and considerations:-
Risk of Foreclosure
The most glaring and also significant risk connected to secured loans is the possibility of losing the property used as collateral in the event that the borrower defaults. Foreclosure is a serious matter that can severely impact upon a person both financially and emotionally.
Equity Reduction
Another risk in this venture is the reduction of a property’s equity and this happens mainly with Home Equity loans or HELOCs. This can adversely affect the sale of the property or its worth if one wants to use it as collateral for future loans.
Market Fluctuations
One factor to consider when thinking of or applying for a secured credit facility with a home as collateral is the fact that the real estate market fluctuates. If at any point in the loan term, the value of the property drops significantly, you would end up owing more than the worth/value of the property.
Criteria for Qualification for Loan Secured by Property in Norway
In order for any bank to approve a loan, it is standard practice that they carry out credit assessment to be sure that the applicant qualifies for the facility they are applying for. The apex bank of each country determines the benchmark for this assessment, how it is to be carried out and what constitutes a pass mark for approval.
Every country has their peculiarities when it comes to monetary policies and the likes. For example in Norway, there are banks referred to as niche banks; these banks are authorized to make exceptions for borrowers that regular banks will not approve.
Below, we discuss 2 major criteria for getting approved for secured loans:-
Ability to Repay
This may sound as a no-brainer but it is important to state this requirement. It is important that the applicant has sufficient income to service their debts and the income must be fixed. The credit assessment or check must also prove the following:-
- Sufficient income that can withstand up to 5%increase in interest rate.
- Enough funds for the borrower to live on (day to day expenses) after servicing the debt every month.
- Total debt profile must not be more than 5 times the borrower’s annual income.
Willingness to Pay
The principle of this is that a bank should not approve a loan with security in real estate if the borrower has shown an unwillingness to pay. In practice however, this means that an applicant with a payment notice on their record will not be approved.
Additionally, cases of debt collection are also prone to be rejected. However, we have stated earlier that niche banks make an exception in these cases. These banks have the backing of the authorities to grant loans to borrowers who have lower expenses on their debts.
Conclusion
Having an asset of value such as a home or land that one can put up as collateral for a secured loan is a big plus for a borrower. With this financial tool, an applicant can negotiate lower interest rates, longer repayment terms and more substantial sums of money. However, this advantage also comes with a downside which is the possibility of losing the said property.
In this article, we have discussed the basics of loans secured by property, the benefits and risks and considerations before engaging this option. If you are new to the real estate or financial scene in Norway, we recommend that you consult a financial expert before making a decision. Do not assume that you know all there is to know.
We also alluded to the fact that there are niche banks that offer loans to people who normally, will not be approved by regular banks. You also need to consult an expert to understand that terrain very well before venturing into it.