What Is A Collateral Loan And How Can I Get One? (2024)

A collateral loan is a secured loan that requires the borrower to provide an asset as security for repayment. With these loans, a lender can take possession of your property—the loan collateral—if you fail to repay the loan.

Common examples of collateral loans include mortgages, auto loans and secured personal loans. Some loans always require collateral, but not all do. Getting a secured loan can be beneficial if you have poor credit or need access to funds quickly, as they offer more competitive rates and terms than unsecured loans.

What Is Collateral for a Loan?

Collateral for a loan is an asset or item of value used to secure the repayment of a loan. For a lender, collateral acts as a safety net if the borrower fails to keep up with repayment.

During the repayment period of a loan, if the borrower fails to make payments on time and in full, the lender can seize—or assume ownership of—the collateral to recoup its financial losses. Common collateral for secured loans includes:

• Real estate
• Stocks
• Bonds
• Cars
• Jewelry
• Non-retirement savings accounts/certificates of deposit (CDs)
• Insurance policies

How Do Collateral Loans Work?

With a collateral loan—commonly referred to as a secured loan—the borrower offers an asset as collateral to obtain the financing. This collateral can be a car, house or other valuable possession. The lender uses the collateral as security and, if the borrower fails to repay the loan, the lender can take possession of the asset and sell it to recover its losses.

A common example is a mortgage. When you buy a house, your home serves as collateral for your home loan. If you default on your mortgage, your lender can foreclose on your house, take ownership of the property and auction it off to recoup the balance of your loan.

If you don’t think a secured loan is right for you, an unsecured loan might be a better choice. With an unsecured loan, there is no collateral or asset that a lender can take possession of if you default. Most of the lenders who offer the best personal loans only offer unsecured loans, but there are options for the best secured personal loans.

For individuals with poor credit scores or those looking for larger loan amounts, collateral loans can be a good option since they lower the lender’s risk and may come with lower interest rates. However, securing a loan with collateral means you could lose your property if you default. Thoroughly review the loan agreement and understand the terms and conditions before agreeing to a collateral loan.

Pros and Cons of Loans With Collateral

Some loans, like mortgages or auto loans, will always be secured with collateral. Personal loans, though, don’t always have collateral.

Collateral loans may be a good option if you have bad credit or want to qualify for a lower interest rate. However, they’re not a good fit for every borrower, so carefully consider the pros and cons of these loans before accepting one:

Pros

• Easier to qualify. Collateral loans are usually easier to qualify for than unsecured personal loans, as the collateral reduces the lender’s risk.
• Lower interest rates. Since these loans are secured with collateral, interest rates can be lower than those on unsecured loans.
• Larger loan amounts. When using collateral to secure a loan, you may be eligible for larger loan amounts than if you were applying for unsecured funds.
• Establish or improve credit history. As with other loans, making regular, on-time payments on a secured loan could help improve your credit score.

Cons

• Risk of losing collateral. If you default on your loan payments, you could risk losing your collateral to the lender.
• Additional costs and application hurdles. Secured loans may require more upfront costs and fees than unsecured options due to appraisal, inspection or processing fees. Make sure you understand how these costs will affect your overall budget before taking out a loan with collateral.
• Limited eligibility. Not everyone qualifies for a collateral loan. You must have the ability to pledge an asset of value in order to be eligible, which may not be feasible for some individuals.

How To Get a Collateral Loan

To get a collateral loan with the most competitive rates and terms, shop around and compare different lenders before making a decision. Depending on the financial institution, it may be possible to prequalify to see the rates you’ll likely be offered.

Once you select a lender, a loan officer will guide you through the application and underwriting process. Getting a collateral loan usually requires meeting certain lender requirements. Criteria may include:

• Credit score
• Income verification
• Appraisal of your collateral
• Legal paperwork associated with the asset being used as collateral

As part of the loan verification process, the lender may order an appraisal to assess the value of your collateral before issuing final approval. This isn’t always necessary, but often required when using a home as collateral. The lender will also review your income and credit history to make sure that you’ll be able to make regular payments on the loan.

How To Apply for a Collateral Loan

Take these steps to apply for a collateral loan:

1. Gather documentation. Before applying for a collateral loan, gather necessary documents such as proof of income, financial records, paperwork associated with the relevant collateral and any other necessary documentation. Lenders can require other documentation, but having this information ready can streamline the application process.
2. Compare lenders. Shop around to find competitive interest rates and repayment terms that meet your budget. Not all lenders offer secured personal loans, so check with a lender representative before applying. Some lenders may offer an online preapproval or prequalification process.
3. Submit an application. Once you have selected your lender, submit an application with the required information, documentation and details about your collateral asset. Visit the lender’s website to find out how to apply. In some cases, you may need to apply for a collateral loan in-person or speak to a loan officer to complete this process.
4. Collateral appraisal. With a secured loan, it may be necessary to have your collateral appraised. This is to ensure the collateral is valuable enough to secure the loan and cover any possible losses. The lender will order an appraisal prior to issuing final approval of the loan amount, and the cost will be rolled into your closing costs.
5. Receive loan agreement. Once your loan moves through underwriting and verification, the lender will provide a signed copy of the loan agreement outlining repayment terms. Review the documents carefully to ensure you are aware of your rights and responsibilities once you accept the loan.
6. Begin repayment. When the lender disburses the loan proceeds, you can use the funds from your loan for the purpose specified in your loan agreement. Make sure you make all payments on time and in full to avoid defaulting on the loan and losing your collateral.

What Happens When You Don’t Repay Your Collateral Loan?

If you fail to repay your collateral loan, the lender has the legal right to seize the collateral item and sell it to recoup the outstanding debt. This can result in you losing your valuable possessions and will cause damage to your credit.

For that reason, it’s essential to carefully consider the terms and conditions of a collateral loan and have a plan for repayment. Before accepting any loan, use a loan calculator to verify the loan payments can fit into your budget.