Can a Bank or Credit Union Change an Unsecured Loan to a Secured Loan?

If you have an unsecured loan, such as a personal loan, a student loan, a credit card or even an unsecured business loan, your lender generally cannot suddenly demand collateral. However, if you default on the loan, your lender might use your default as leverage to get collateral from you, and if your lender sues you for nonpayment and gets a judgment, the judgment might become a lien on real estate.

How Do Bank Loans Work?

Millions of people borrow money from banks every year for various reasons, from debt consolidation loans to home loans and car loans to student loans and business loans. When you borrow money from a bank, you pay the money back plus interest. Bank loans can be secured or unsecured.

Secured vs. Unsecured Loans

A secured loan is a loan that is backed by collateral. That is, it's secured by a lien on property. If you don't repay the loan as promised, the lender can take the property from you and sell it to satisfy the loan.

An unsecured loan is a loan that has no collateral. Unsecured loans typically have higher interest rates than secured loans, because the lender is taking on a greater risk.

What Is a Lien?

A lien is an interest that attaches to the property of another person to secure a debt. If you have a lien on a piece of property, it means that although you don't own it, you have the right to take it and sell it to satisfy the debt (although different types of liens have different requirements for doing this).

The property with the lien attached is called collateral for the loan. A lien on collateral gives the lender some security, because if you don't pay back the debt, the lender can take the collateral and sell it to satisfy the obligation. This is why a lien is also called a security interest.

Types of Unsecured Loans

Common types of unsecured loans include student loans, credit cards and personal loans. Medical bills are also unsecured debts, although they aren't "loans" but are past due accounts.

Types of Secured Loans

Most consumer secured loans are mortgages and car loans. You may also end up having a secured loan for certain large appliances, such as washers and dryers, refrigerators and the like, if you pay for them over time using store credit. Many business loans are also secured loans and require the business owner to agree that the lender has a lien on all the business assets.

Consensual Liens vs. Non-Consensual Liens

Most liens are consensual liens; that is, the borrower agrees to give the lender a lien in exchange for receiving the money. Mortgages, vehicle liens and other property liens given at the time the loan closes are consensual liens. An unsecured loan does not require a borrower to provide collateral to secure a loan; if you sign up for an unsecured loan and one is offered, that's what you get.

A non-consensual lien is a lien that is created on your property without your permission. They include things like tax liens and judgment liens.

The bottom line is that a lender cannot lien your property without your consent unless it sues you first and gets a judgment. Then, it may be able to get liens on your property, depending upon the laws in your state.

Collateral for a Loan: Examples

Mortgage Example. If you buy a new house and you borrow money to pay for it, the lender will agree to give you the money as long as you give the lender a mortgage on the house. A mortgage is a type of lien specific to real estate. You'll sign a mortgage document, which the lender will record in the county where the house is located. If you later default on your mortgage payments, the lender can initiate a foreclosure and try to sell the house to recover its loss.

Car Loan Example. Just like when you buy a house on credit, when you buy a car and finance the purchase, you grant the lender a lien on the car. With vehicles, the lien is typically evidenced by a notation on the car title (although it varies by state); in most states, your name will be listed on the title as the owner, and the lender's name will be listed as a lienholder. When you finish paying off the car, the lender will mark the lien satisfied, and you'll get a new title with the lender's name removed. If you don't make your car payments, the lender can come take the car and sell it to satisfy the debt.

Business Loan Example. Businesses borrow money all the time, particularly small businesses. If you're a small business owner and you need a loan to buy equipment or fund your operations, most banks will require you to give them a lien. For the purchase of hard assets, like equipment, the lender will ask for a lien on the item you're buying. Otherwise, it may require an all-asset lien, which is a lien on everything the business owns, including inventory, equipment, accounts receivable and intellectual property.

These types of liens are created by entering into a security agreement; the lender then must record a document called a UCC-1 Financing Statement in the state where the assets are located. If you default on the loan, the lender can repossess all the assets and sell them after providing notice to you as required by the Uniform Commercial Code.

Changing Unsecured Loans to Secured

If you're struggling to make your loan payments on an unsecured loan, you might ask the lender for a forbearance agreement, which is an agreement that the lender will not sue you on the debt. In return for agreeing not to sue, the lender might ask for collateral to secure the forbearance agreement.

For instance, if you fall behind on payments on an unsecured business loan and the bank demands payment in full immediately, you might agree to give the bank a mortgage on your personal residence in exchange for their agreement to give you what amounts to a "do-over."

Judgment Liens: Non-Consensual Liens

A judgment lien is a non-consensual lien created when someone gets a judgment against you. Many states have laws that provide for judgment liens.

In New Jersey, for example, if someone gets a money judgment against you, the judgment creditor can record the judgment in New Jersey's capitol, Trenton, and have it docketed as a statewide lien. The judgment then acts as a lien on all real estate you own within New Jersey. In Pennsylvania, on the other hand, a judgment automatically becomes a lien, but only in the county where the judgment was entered.

Tax Liens: Non-Consensual Liens

Tax liens are non-consensual liens created when you get behind on your taxes. Unpaid property taxes create a lien on that particular property; if you don't pay the property taxes on your house, the taxing authority (the city or county) has a lien on the property that lasts until the taxes are paid. On the other hand, income tax liens, such as IRS liens and state tax liens, attach to all of your property, real or personal, in the state where filed.

Effect of Repossession and Foreclosure

If you do have a secured loan and you default, and the lender takes the collateral and sells it, you're not necessarily off the hook. The lender will sell the property for as much as it can get, but it still might not be enough to pay off what you owe. The difference between the sale price and the balance on the loan is called a deficiency balance, and the lender can go after you for that amount. For example, if you owe $20,000 on your car but stop paying and the lender repossesses it and sells it for $15,000, you'll still owe $5,000.