Collateral Loans - What you need to know

Last Updated: November 26, 2013

Collateral loans

Also known as secured loans, collateral loans are loans obtained from banks and other financial institutions where the borrower offers collateral (property, securities, valuable items) that may be sold by the lender in the event that the borrower cannot repay the loan amount. Since collateral loans provide an inherent form of repayment guarantee and reduce risk, they are typically offered at lower interest rates than unsecured loans.

Secured vs. unsecured loans

While secured loans or collateral loans are approved based on a collateral's value, unsecured loans are issued on the basis of a borrower's credit worthiness. Since your credit rating dictates whether or not your loan will be approved, it is very important for a borrower to have high credit scores. As there is nothing to guarantee repayment of the loan, unsecured loans are considered to have higher risk than collateral loans. To offset these risks, unsecured loans carry higher interest rates than secured loans. Even so, these rates are considerably lower than what you’ll get with credit cards. But unlike interest on mortgage loans, interest for unsecured loans is not tax deductible. Secured loans are ideal for those who don’t have stellar credit ratings, but require cash for emergencies and other reasons.

What to use as collateral

Collateral loans can utilize different types of valuable assets as collateral in order to secure approval. While it’s common for properties (an entire home or a piece of land) to be put up as collateral for a loan, people also use bonds or stocks to establish repayment guarantees. Should a borrower default on loan repayment, the collateral is awarded to the lender as a form of payment. The lender is given the rights to sell the collateral, even if the repayment amount is only a fraction of the full value of the collateral. In this case, the lender can sell the asset but the borrower or previous owner must be given any money received beyond the payment amount that is rightfully theirs. Apart from existing properties or belongings (high-value items like jewelry and other goods), a collateral loan may also be approved based on what is known as "expected collateral." An example of expected collateral is the return you will get from an investment, such as crops to be harvested at the end of the season. As the crops are considered to be collateral, they will be given to the lender when they are harvested should the borrower default on loan repayment.

Getting a collateral loan

It’s actually quite easy to find available options because lenders for secured loans can be found online. You can search for them yourself or you can check out one of the many broker sites that allow you to compare several loan options at once. Keep in mind that there are many different lenders out there, so it's worth your while to compare as many as you can to find the best available option. Going for a collateral loan with the lowest interest rates will always make sense, but be sure to pay attention to all the terms and conditions. If you have any questions or concerns about the terms and conditions of the collateral loan, don’t hesitate to raise them when you request a quote. Quotes are provided for free, which gives you a golden opportunity to ask about anything that is not crystal clear. Patience is truly a virtue here – you're going to have a lot of options that need to be weighed. Taking out a loan is a serious matter, and you should take your time before making a decision.

The "ins" and "outs" of collateral loans

Generally speaking, the amount of the loan will depend on the collateral you have to offer. As such, the higher the value of your collateral, the higher the loan amount you can expect. Apart from the loan amount, the interest you are charged for collateral loans may also be a function of the kind of collateral you have. There are online lenders like, for example, that are able to offer very affordable interest rates, even as low as 1% interest every month.

Should a borrower default on his loan payments and in the meantime the collateral loses value, the full loan amount must still be repaid. For example, let's say you borrowed $200,000 and used your property of the same value as collateral. If your property depreciates by $50,000, your collateral no longer breaks even with your loan amount. In the case of default, you will still have to pay $50,000 after the lender takes your property, because the collateral you gave them is only worth $150,000. Of course, if the borrower does not default, the full loan amount will still have to be paid as guided by terms and conditions of the collateral loan.

In order to avoid the above-mentioned pitfalls, many people choose not to take out a loan that equals the value of their collateral. Instead, the amounts for collateral loans typically represent only a portion of the full collateral value. Naturally, the higher the value of a collateral, the higher the loan amount that will be approved. To help you better manage your loan, keep in mind that it's best to borrow only what you need. Remember too that you will have to deal with interest rates. Since this is a "necessary evil", shop for a lender that offers the lowest interest rates.

If you’re applying for collateral loans online, the process generally involves providing a basic description of the item you wish to use as collateral. If the collateral is accepted, the lender will have it picked up by courier. Once the value of the collateral is verified, the cash you need will be forwarded to you immediately.

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