Bad Credit Loans Using Collateral: A Complete Guide

Having a bad credit score can make it incredibly difficult to get approved for loans from traditional lenders like banks or credit unions. Many people with bad credit feel like they have no options when they need access to financing. However, there are specialized lenders that work with borrowers who have less-than-perfect credit. One option is to take out a loan that uses collateral.

What are collateral loans and how do they work for borrowers with bad credit? I’ll explain everything you need to know about collateral loans, including the pros and cons, types of collateral, and how to find a lender.

What is a Collateral Loan?

A collateral loan is a secured loan that requires the borrower to put up an asset as collateral for the loan The collateral acts as security for the lender in case the borrower defaults on the loan.

Here’s how collateral loans work:

• The borrower pledges an asset they own, like a car, jewelry, collectibles, real estate, or investments, to secure the loan.

• If approved, the lender gives the borrower a loan amount up to a percentage of the collateral’s value. For example, a lender may loan up to 50% of a car’s value.

• The borrower makes regular payments on the loan. If they pay it back on time and in full they get their collateral back.

• If the borrower defaults, the lender can seize and sell the collateral to recoup their losses.

Collateral loans tend to have lower interest rates than unsecured loans because they are less risky for lenders. Even borrowers with bad credit may qualify for collateral loans they wouldn’t otherwise get approved for.

Benefits of Collateral Loans for Bad Credit

Collateral loans offer several advantages that make them useful options for borrowers with less-than-perfect credit:

Higher approval odds: The collateral reduces the lender’s risk, so approval is easier even with bad credit. Lenders focus more on the collateral’s value than the borrower’s credit scores.

Better rates and terms: Interest rates may be lower compared to unsecured loans. Lenders may offer larger loan amounts and longer repayment terms since the collateral protects them.

Quick access to cash: Collateral loans can provide fast access to cash since they are easier to qualify for. Borrowers can get approved in days rather than weeks.

Chance to rebuild credit: Making on-time payments can help improve your credit over time. Paying off a collateral loan responsibly shows you can handle credit.

Retain ownership: The collateral remains your property unless you default. You can continue using or enjoying the asset while repaying the loan.

Flexible options: Many types of assets can be used for collateral, giving you multiple options to choose from.

Drawbacks of Collateral Loans

While collateral loans have advantages, there are some potential downsides to consider as well:

Risk of losing collateral: If you default, the lender can take possession of your collateral. It’s possible to lose a valuable asset like a home or car.

Upfront costs: Appraisal, documentation, and processing fees range from 1% to 10% of the loan amount. There may be storage costs for physical collateral also.

Limits on the collateral: You won’t have full access to or control over assets used as collateral until the loan is paid off. For example, you couldn’t sell a home used as collateral.

Fluctuating valuations: If the collateral decreases in value, the lender may ask you to repay part of the loan early or add more collateral. Market fluctuations can impact loan terms.

Specialized lenders: Because collateral is required, fewer lenders offer these types of loans compared to conventional loans. You have a smaller pool of lenders to shop around with.

Short terms: Many collateral loans have terms of two years or less, so the payments are spread over a shorter time frame compared to other loans.

What Assets Can Be Used as Collateral?

Many types of assets can potentially be used as collateral for a loan, including:

• Vehicles – Cars, trucks, motorcycles, RVs, boats, airplanes
• Real estate – Houses, condos, land, rental properties
• Investments – Stocks, bonds, mutual funds retirement accounts
• Luxury items – Jewelry, fine art, antiques, collectibles
• Equipment – Construction equipment, farm equipment, medical equipment
• Commodities – Gold, silver bars, coins, diamonds, gemstones

The lender will appraise the item and loan an amount equal to a percentage of its resale value. Easily valued and sold assets make the best collateral. Unique, outdated, or sentimental items may be harder to use.

The lender wants enough value to cover the loan if they have to liquidate the asset. Stable assets like real estate that hold value are ideal. Cars, jewelry, art, and equipment depreciate over time but can still be used.

How Do Collateral Loans Work for Bad Credit Borrowers?

For borrowers with less-than-perfect credit, a collateral loan can provide financing that may be hard to find elsewhere. Here is the general process:

1. Choose collateral – Select an asset to pledge against the loan, such as a paid-off vehicle. Make sure you have clear ownership and the title or deed.

2. Apply for loan – Fill out a collateral loan application with details on your chosen asset. The lender will review your credit but focus more on collateral.

3. Get approved – If approved, you’ll get a term sheet listing the loan amount, interest rate, fees, and repayment terms. Rates vary based on credit, collateral, and lender.

4. Provide collateral – Sign paperwork to pledge the asset as security for repayment of the loan. With a vehicle, you would turn over the title to the lender temporarily.

5. Receive funds – The lender disburses the loan funds to you, generally depositing into your bank account within a few days of approval.

6. Make payments – Repay the loan plus interest over the set term to get the collateral back. Autopay is usually required.

7. Regain collateral – When the loan is paid in full, ownership and control of the collateral returns to you.

Be sure to carefully review the loan terms and requirements before committing to borrow. Defaulting could put your collateral at serious risk.

What is a Secured Loan?

Secured loans and collateral loans refer to the same type of lending product. A secured loan requires collateral that the lender can seize if the borrower stops making payments. Almost any asset used as security for the loan makes it a secured loan.

The other main type of loan is an unsecured loan, which has no collateral tied to it. Common unsecured loans include personal loans, student loans, and credit cards. The lender relies entirely on the borrower’s creditworthiness and has no recourse if they default other than collections.

Secured or collateral loans have distinct advantages for borrowers with shaky finances or bad credit. They provide an alternative path to borrowing with more flexible qualification criteria.

However, borrowing unsecured is less risky if you do have strong enough credit to qualify. You won’t put your assets in jeopardy.

Types of Assets That Can Be Used as Collateral

Many types of personal and business assets can be pledged as collateral for a loan. Common options include:

Vehicles – Cars, trucks, motorcycles, RVs, boats, and planes are popular collateral. The lender places a lien on the title.

Real estate – Houses, condos, rental properties, vacant land, and commercial property can collateralize large loans. The lender places a lien.

Investments – Brokerage accounts, retirement accounts, annuities, and certificates of deposit can be used. The accounts are still in your name but access is restricted.

Luxury items – Jewelry, watches, fine art, antiques, collectibles, wine collections, furs, designer handbags. Items are appraised and stored by lender.

Business equipment – Machinery, farming and construction equipment, vehicles, tools, generators. Lender files UCC-1 financing statement.

Commodities – Precious metals like gold and silver, diamonds and gemstones. These must be stored by the lender during loan term.

Make sure to only use assets you own 100% without any liens against them already. Anything with sentimental or utility value is risky as collateral.

Pros and Cons of Using Different Asset Types as Collateral

The advantages and disadvantages can vary depending on which asset you use to secure a collateral loan:

Vehicles

Pros – Easy to value and sell, convenient to pledge title, retain use of vehicle.

Cons – Depreciates over time, must be maintained and insured.

Real Estate

Pros – Holds value, allows large loan amounts, lender has recourse.

Cons – Lengthy application, expensive to liqui