Common secured loan mistakes borrowers make

A secured loan can be a great option for New Zealand borrowers, particularly people who want to borrow a larger amount of money. When someone takes out a secured loan, the lender uses an asset – often the thing they have borrowed to buy – as security.

This means if something happens and the borrower cannot pay back the loan, the lender can sell the security and recover what they are owed. Things don’t always go to plan, though, and there are a few things that can catch borrowers out.

Here, we’ll explain a few of them and what you can do to avoid making similar mistakes.

What is a secured loan?

A secured loan is one that is backed by an asset used by the lender as collateral. That could include things like a car loan, where the lender uses the car as security until the loan is paid off. Sometimes a house could be offered as security when someone is borrowing for a larger expense, like a wedding or medical costs.

It gives lenders an extra layer of protection. If the borrower cannot repay the loan, they can sell the asset and recover any money that is owed.

That is quite different from an unsecured loan, where the lender has nothing to fall back on if things don’t go to plan. Lenders often offer lower interest rates for secured borrowing because it is less risky.

Why do secured loans require extra care?

All borrowing should be considered carefully, but there are a few things to think about with secured loans.

You are putting your asset at risk if you miss repayments. If you’re borrowing and offering your car as security, for example, you could end up losing your car if you don’t make your scheduled loan repayments.

You may be taking on a larger loan – secured loans tend to be bigger. This means it’s particularly important to consider how it fits into your financial life.

If you have a long repayment term because the loan is bigger, it is something you need to consider in your longer-term financial planning.

Mistake 1: borrowing more than you need

Sometimes people borrow more than they really need to. As lenders have servicing criteria that must be met, this would still be financially manageable for the borrower, but it means they may end up paying more in interest than they would have if they had just stuck to what they really needed.

It can happen because borrowers might be approved for a larger loan than they require, or they add on things during the process - maybe additional extras for a car – that add to the cost of the purchase they’re financing. It means more of a financial obligation than you might have otherwise faced, and can mean your loan sticks around longer. You can avoid this by only borrowing what you require. Set a budget before you begin and ensure your lending matches it. Focus on what you are comfortable with, can afford, and need, not what you are approved for.

Mistake 2: ignoring the risk to your asset

No one goes into a loan expecting things to go badly. It’s important to understand the potential risks, though, particularly if you are offering an asset as a security.

If the loan is secured against a vehicle or other asset, your lender might repossess it if you are not able to pay your loan. It’s really important that you make sure you make your payments on time. When you are applying for a loan, consider whether you could still manage your repayments if your financial circumstances changed in an unexpected way.

Mistake 3: choosing an unrealistic loan term

It’s worth taking the time to make sure your loan term is a good fit. Longer loan terms mean lower monthly repayments but usually increase the total amount of interest paid over the life of the loan.

Depending on what you’re borrowing for, a long loan term may mean you’re still repaying it after the asset you’ve bought has lost value. Borrowing for a car over seven years, for example, can mean you are in negative equity towards the end of the term.

Shorter terms generally mean lower interest costs than a longer-term loan, but higher repayments, so it’s important to make sure you can manage these.

Mistake 4: not comparing lenders and loan terms

When you’re taking out a loan, it makes sense to look at your options. At better finance™️, we can compare options such as the interest rates, fees and what flexibility each lender might give you. Small differences can really add up over time, and it’s worth finding a lender who’s a suitable fit.

Mistake 5: overlooking fees and loan conditions

You’ll be familiar with the interest rates being charged, but there are other things that go into the cost of a loan. You will probably pay establishment fees, ongoing service fees, and there may be early repayment fees if you want to pay off your loan more quickly. The better finance™️ team can help with this, too, to ensure you have a full understanding of the cost of your lending.

Mistake 6: rolling multiple debts into a secured loan without a plan

Debt consolidation can be an option for people who have multiple loans that are difficult to keep track of, or who want to combine their payments into one. 

It can be a handy personal finance tool, but it may also extend the repayment period of your debt and may also mean a higher interest rate bill overall. We can help you consider whether this is something that could work for you to improve your overall long-term financial health.

Mistake 7: not considering asset depreciation

Assets tend to depreciate over time, particularly assets that tend to depreciate with use, such as cars.

This is something to keep in mind if you’re offering an asset as security. What will the value of the asset be over the term of your loan? If it reduces in value faster than your loan balance decreases, you could end up in negative equity.

Often, this doesn’t matter a lot, but it can mean it’s harder to upgrade a car, for example. It can also mean that if your lender has to sell the security to help clear the loan, you could end up with debt still owing.

Mistake 8: taking a secured loan without an emergency buffer

It’s always a good idea to have an emergency fund in place to help you out in cases of unexpected financial emergencies. This is especially true when you’re taking on a financial commitment such as a secured loan.

An emergency fund can give you a buffer to fall back on if something happens that disrupts your income or throws up a surprise expense.

How to use secured loans responsibly?

• Borrow within your budget: Only borrow what you need and what you can afford to repay. Lenders will do their own assessment of affordability, but you need to be comfortable with it as part of your budget and financial objectives, too.
• Choose realistic loan terms: Choose a loan term that works for you. Longer terms generally mean lower repayments but higher interest costs overall.
• Understand loan conditions before signing: At better finance™️, we can explain things like how you can expect a lender to respond if you want to pay back a loan early or change the terms of your borrowing. Understanding the fine print is important.
• Maintain financial flexibility: Try to give yourself some room to move in your budget so that you can cope with changes in financial circumstances that might come your way.

When can secured loans be a smart financial tool?

Secured loans can be a really helpful tool in lots of situations. You might be financing an essential purchase like a vehicle. You might have a few different debts and want to consolidate them into one that’s easier to keep track of, or that will save you money. With a clear repayment plan, a secured loan could be a way to improve your overall financial circumstances.

Frequently Asked Questions (FAQs)

What assets can be used as security for a loan in NZ?

Many types of assets can be considered, depending on the lender. It’s common for borrowers to use things such as their vehicle or a property.

Do secured loans always offer lower interest rates than unsecured loans?

The rate you are offered will depend on your overall financial information, including your credit check information, but lower rates may be offered where security is available.

Can a lender repossess the asset immediately after a missed payment?

Generally, no; a lender is required to give you at least 15 days' written warning that they intend to repossess the asset being used as security. There are some situations, however, where a lender can take more urgent action.

Can I repay a secured loan early?

Generally, yes; however, there may be early repayment fees to consider. We can help you to determine what they might be and how that would work.

Is a secured loan better for borrowers with lower credit scores?

A secured loan may give a lender more reassurance that you will repay your loan, which can be particularly helpful for people with lower credit scores.

Got questions?

If you have questions about secured loans or any personal lending, get in touch with the team at better finance™️. We’re experts and here to help.

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion, and seek independent guidance.