Collateral, also commonly referred to as security, is a valuable asset that the borrower owns and uses to secure a loan. In the event that the borrower defaults on the loan, the lender has the right to seize the asset, sell it and use the proceeds to cover the owed debts. Often, using collateral for a loan leads to better rates, a larger loan amount and generally better terms because it reduces the lender’s risk. There are several types of assets you can use as collateral, depending on the lender.
What items can be used as collateral for a loan?
Not all assets can be used as collateral. Below is a list of common collateral types for specific loan purposes:
Personal loans
Personal real estate
Home equity
Personal vehicles
Cash or savings accounts
Investment accounts
Paper investments
Paycheques
Fine art, jewelry or valuable collectibles
Auto loans
The vehicle being purchased
Owned personal vehicles
Home equity
Cash or savings accounts
Investment accounts
Paper investments
Business loans
Personal or commercial real estate
Home equity
Business assets, such as equipment or machinery
Personal or commercial vehicles
Accounts receivable
Inventory
Farm assets and products
Natural reserves
Commercial cash or savings accounts
Investment accounts
Paper investments
Blanket lien
Insurance policy
Fine art, jewelry or valuable collectibles
Keep in mind that every lender is unique. One lender might accept one type of collateral for your loan while another lender doesn’t.
Frequently asked questions about specific types of collateral
Yes, a house or other piece of real estate can be used as collateral, so long as it is owned by the borrower. Rented or leased property can’t be used as collateral because the borrower doesn’t have the right to give it up. Home equity, the difference between the current value and outstanding obligations, can be used as collateral for a personal loan too.
A personal loan using your car as collateral is absolutely possible. This is also known as a car title loan. With a car title loan, you use your vehicle as collateral to get a loan that you can use for whatever you want. Auto loans or car loans work in a somewhat similar way, except they are used to purchase a vehicle with the vehicle as collateral.
Registered accounts like RRSPs cannot be used as collateral.
How do collateral loans work?
Collateral loans are also referred to as secured loans. When a borrower applies for a collateral loan, they agree to give up a specific asset in the event that they cannot repay the loan.
In the eyes of the lender, collateral loans are favourable because there’s less risk. Even if the borrower is unable to make payments, they have the collateral as back up.
The amount of your loan depends on the value of the collateral. In addition, a portion of the collateral’s value is usually considered for the loan, not the entire value. For example, if you have a car worth $5,000 being used as collateral, your loan might be approved for 60% of that value, or $3,000. This is to provide more protection to the lender.
How much is my collateral worth?
What you use as collateral will determine the value. Generally speaking, collateral loans require more paperwork because the asset often needs to be appraised. For example, a car or an heirloom would need to be valued because an ordinary person wouldn’t know the exact worth. However, some assets are easy to value, such as saving or investment accounts. In this case, simply check the current balance.
Remember that a portion of the collateral’s value is accepted for the loan, usually between 50% and 90%. The exact percentage depends on the asset and lender.
Does collateral have to equal the loan amount?
No, collateral used for loans doesn’t have to be exactly equal to the borrowed amount. However, the collateral must exceed the loan amount value. If your collateral is worth less than the amount you want to borrow, you’ll have trouble getting approved.
What is LTV?
LTV stands for loan-to-value ratio. This is a simple calculation that lenders use to calculate the percentage of your debt relative to the value of your assets. The ratio communicates how much of your assets you truly own versus the amount of debt outstanding against them. The more assets you fully own, the more favourable you are in the eyes of lenders.
Which lenders offer collateral loans in Canada?
In general, all lenders should accept some form of collateral. Collateral loans, or secured loans, are much safer for the lender so there’s little reason for them to reject collateral. With that being said, the type of collateral that’s accepted can vary from lender to lender.
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What to expect when applying for a loan with collateral
There is usually more paperwork involved with secured personal loans compared to unsecured loans. Not only do you need to get the asset valued, you will be required to provide specific details and documentation related to the asset. This can make the application process longer as opposed to an unsecured loan.
When you use collateral, you run the risk of losing that asset if you default on the loan. Be sure that you’re willing to part with the collateral before using it to secure a loan.
Benefits and drawbacks of using collateral for a loan
Increased odds of approval. Since the lender takes on less risk with a collateral loan, you have a better chance of being approved.
Lower interest rates. Because collateral loans are less risky, the interest rate is typically lower.
Better terms. The terms tend to be more favourable with a collateral loan too. This could be a longer term, higher loan amount or better repayment terms.
Bargaining chip. If you receive an offer from a lender that doesn’t include everything you want, you can use collateral to negotiate.
Repossession. In the event that you default on the loan, the lender has the right to repossess the collateral and sell it to use the proceeds to cover the debt. Even though no one plans for repossession, it can happen to anyone.
Longer term. Longer terms mean lower payments, but higher interest and risk of negative equity. Even though a longer term is possible with collateral, that doesn’t mean it’s necessarily the right choice.
Overspending. When taking on a new loan, you should always consider if you’re overspending. The more financial obligations you have, the greater the risk of default.
Credit reporting for secured personal loans
Just like with unsecured personal loans, the lender will report your payment history to the two credit bureaus: Equifax and TransUnion. If you make any late payments or default on the loan, it will remain on your credit report for six or seven years from the date of the original missed payment. However, if the collateral tied to your secured personal loan is repossessed or confiscated, this will add even more negative marks to your credit history.
How to get a personal loan without collateral
Not sure you want to put your house, car or grandmother’s silver on the line? Unsecured personal loans are actually more common than secured loans. The application process is nearly the same. The only difference is you don’t need to identify, value and provide additional documentation about collateral.
You can typically get an unsecured personal loan if you have:
Good or excellent credit, which is usually a score of 650 or higher.
There are a variety of options when it comes to taking out a personal loan, whether you decide to secure it with collateral or go with an unsecured loan. When looking into a secured loan, consider your ability to repay the loan very seriously before taking one out. Defaulting on a secured loan means more than just damaging your credit score – you could also lose the asset you put up for security.
You might be. The requirements vary between different lenders in Canada, but you may be able to get a collateral loan with bad or poor credit if your asset matches the lender’s criteria and you can prove your ability to repay the loan. In fact, collateral loans are typically easier to get than unsecured loans because you reduce the lender’s risk by offering an asset you own should you default on your loan payments.
In the case of personal loans, you can usually use collateral loans for any legitimate purpose. Car loans are typically restricted to cars or other recreational vehicles. Business loans are generally for business purposes only.
Different lenders require different information and documentation. Generally, you’ll need to provide your personal contact information, Social Insurance Number (SIN), date of birth, bank account information and employment and income information. For a business loan, you’ll also need to supply relevant information about your business.
Some loans require collateral because the lender wants to reduce their risk. This is especially common with business loans.
Veronica Ott was a writer at Finder. She's written for numerous finance and business websites including Loans Canada, Borrowell and Fresh Start Finance. She previously worked as a professional chartered accountant in the private equity and advertising industries.
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