What Is A Collateral Loan?

collateral car

If you are looking for a loan, you may or may not have heard of the option of a collateral loan. Essentially, collateral is something valuable you are offering a lender temporarily to help you secure a loan.

When you borrow money through a collateral loan, you are agreeing to hand over your property to the lender if you fail to repay the agreed amount for the loan, whether that be a vehicle, a house or an item of value.

Collateral loans make it possible for people to obtain large amounts of money even if they have a bad credit score. You are able to leverage the value of your asset to access the finance you need. The lender receives piece of mind knowing that they can repossess the collateral if the customer fails to repay, and they can recoup their initial investment. (Source: Mischon Capital)

How Collateral Works

If you pledge an asset as collateral when securing a loan, the lender has a right to take whatever you have pledged for their own. They are then legally allowed to sell on your property (which is now theirs, as agreed by you in the contract) in order to obtain the money which, they should have been paid as part of your agreement. However, of course, lenders prefer to get their money back in cash form, but they will have to take action against you if they have no other option.

Types of Collateral

In order to secure the loan, as mentioned you must put up an asset against your loan re-payment promise. Any asset which the loan provider accepts as collateral or which is allowed by law can serve as your collateral.

Typically, lenders prefer the assets to be items which are easily valued and can be sold for a cash return. You can even use the money in your savings account as an asset, which is very much favoured by lenders as it is easily valued and in the form of cash.

Other forms of collateral include:

  • Vehicles
  • Real Estate (this can include the equity in your home)
  • Cash accounts (bear in mind that retirement accounts do not always qualify)
  • Machinery
  • Equipment
  • Investments
  • Valuables and collectables
  • Future payments from customers
  • Insurance Policies

Alternatives to Collateral Loans

Unsecured loans such as personal loans and credit cards involve no form of collateral, hence they are "unsecured." Instead, the approval process relies on the individual's affordability, credit history and history of repayment. Since the lender has nothing to retrieve if the individual does not repay, they have to add higher interest rates than secured products and limit the amount the customer can borrow. In the event of default, late fees are typically added.

Another option of adding security without physical collateral is via adding a guarantor or personal guarantees. This is an extra individual or director of a business who agrees to co-sign a loan agreement and cover any repayments that the main beneficiary cannot make. You are essentially leveraging their good credit and good name in order to obtain funds. For the lender, they have peace of mind knowing that the guarantor has a good credit history and can repay funds if need be. Read our guides on guarantor loans here.

Further Reading

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