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Also known as a secured loan, a collateral loan is when the borrower guarantees their the cost of their loan by offering up an asset or property as security. The collateral is an item or property that can be taken if the borrower fails to pay back the loan within its terms.
By securing a loan, you’re reducing some of the risk assumed by the lender. When you’re struggling to find a loan with reasonable terms, securing one with collateral could help you lock in a lower annual percentage rate (APR) and better loan terms.
You might want to consider backing your loan with collateral in the following situations:
It reduces the risk to the lender. Lenders specialising in business loans typically want collateral of some kind to minimise their risk of taking you on as a borrower.
If your small business is new or hasn’t yet found its footing, you may not have the revenue to assure a lender that you’re able to keep up with potential payments. Promising an asset or property that’s worth the cost of the loan cuts that risk down.
The same principle applies to complex loans like those for cars, homes or even large personal purchases. All such loans can require collateral to ensure some form of repayment. Sometimes the collateral is the car, home or item you’re buying with the loan.
While you could technically use any valuable asset as collateral against a secured loan, lenders will generally only accept the equity you own in your house as security.
However, you may also be able to use a car, or the equity you have in another property, as collateral. If you’re planning on getting a loan to purchase an expensive asset, the lender may request that the item itself is used as security, in order to reduce the risk they’re taking on by giving you a loan.
Lenders typically offer you less money than the value of the asset you’re putting up as collateral — usually between 50% and 90% — though it can be even lower depending on the lender and the type of asset you’re using.
For example, if you’re using an investment portfolio as your collateral, in order to factor in the volatility of the investment, a lender might only offer you 50% of the value of the investments, just in case they lose value during the term of your loan.
When it comes to borrowing against your house, lenders generally let you borrow 80% of your loan-to-value ratio (LTV). With car loans, you’re usually offered 25% to 50% of the value of the car.
Just like with unsecured personal loans, the lender you take out a secured personal loan with will report your payment history to these credit bureaus: Experian, Equifax and Crediva. If you make any late payments or default on the loan, it will remain on your credit report for 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.
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, except you don’t need to take the extra steps involved with appraising your collateral or providing proof of ownership.
You can typically get an unsecured personal loan with competitive rates if you have:
There are options aplenty when it comes to taking out a personal loan with or without securing it. 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 lose the asset you put up for security.
If a secured loan doesn’t exactly fit your needs, you can consider unsecured loans that don’t require collateral.