Finance

What Are Collateral Loans and How Do They Work?

Personal loans are unsecured loans, meaning they don’t require collateral, but it’s easier getting a Collateral Loans when you’re willing to put up some kind of collateral. The term collateral refers to an asset, like your car, or your home. It helps secures the money you are borrowing, if you can’t pay your loan back, the lender has the right to claim the collateral.

Read more to learn more about what can and cannot be used as collateral for a secured personal loan, and pros and cons of collateral.

What Is Collateral?

Collateral is an asset, such as a car or home, it acts as a protection for the lender, if the borrower defaults on the loan, the lender can take the ownership of the collateral.

A collateral loan can offer a lower interest rate, longer loan term or larger loan amount than with an unsecured loan, like a credit card. But if a borrower can’ t keep up with payments on a secured loan, they could lose their collateral.

There are many types of collateral loan, your mortgage is a type of collateral loan, and if you take out a car loan, the car is the collateral.

Before a lender approves a collateral loan, they will estimate the value of your collateral, then they’ ll determine the size of your loan by offering you a percentage of what your collateral is worth.

Types of Collateral You Can Use

Several types of collateral can be used for a secured personal loan. Your options may include:

  1. Car
  2. Savings account
  3. Piece of jewelry
  4. Investment portfolio
  5. Machinery and equipment
  6. Fine art
  7. Home or other real estate
  8. Insurance policies
  9. Other valuables

Typically, funds in a retirement account like a 401(k) or IRA don’ t qualify as collateral. In addition, some lenders may not accept a car over five to seven years old as collateral.

Pros and Cons of Loan With Collateral

Collateral loan may be the only option for a borrower who has either a damaged credit history or low income, but keep in mind that doing so comes with both pros and cons.

Pros:

  • Help borrower to obtain a loan with a damaged credit history or no credit history at all.
  • Because your collateral reduces the financial risk for a lender, you possibly get lower interest rate, larger amount.
  • A secured loan may help build your credit. Making on-time payments toward a secured loan can help you establish a credit history, but make sure your lender reports your payments to the major credit bureaus.

Cons:

  • Your collateral could be taken by the lender if you unable to pay back.
  • If you use a savings account or CD as collateral, a minimum balance may be required.
  • The lender may restrict how you use the money you borrow.

Can you borrow without collateral?

If you prefer not to pledge collateral, there are some alternatives:

  • Unsecured loan from bank or credit union, like a personal loan or credit card
  • Online loans
  • Get a co-signer to apply the loan with you

How do you apply for a loan with collateral?

When you’ re applying for a loan with collateral, understand these information:

  • How much money you’ re borrowing
  • What the APR is
  • What penalties there are for late payments or an early payoff
  • How much you have to pay back monthly
  • What happens to your collateral if you can’ t repay the loan

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