With great power comes great responsibility â and the same can be said for loans backed by collateral. Securing a loan with an asset provides access to substantial funds while offering lenders a level of security unparalleled by unsecured alternatives. Whether youâre considering a mortgage loan, auto loan or other secured option, collateral loans empower you to take the next step with your financial plans. But you need to be responsible with paying it back, since your property is at risk.
Taking out a loan is often necessary to afford major purchases or expenses. However, lenders want to ensure repayment of the money they lend. As a result borrowers with lower credit scores or incomes may struggle to get approved for a loan. Using property as collateral for a loan provides an alternative solution.
Collateral acts as a form of insurance for the lender. If the borrower defaults, the lender can seize the property to recover the unpaid loan balance. As a result, collateral allows borrowers who may not qualify for a regular loan to get approved.
This guide will explain what collateral loans are, how they work, and the pros and cons of using property as collateral. Read on to learn how putting up property can help you access the financing you need.
What Are Collateral Loans?
Collateral loans, also called secured loans, require borrowers to pledge an asset to the lender. If the borrower fails to repay the loan, the lender can take possession of the collateral. As a result, collateral reduces the financial risk for lenders.
Common assets used for collateral loans include
- Real estate – House, land, commercial building
- Vehicles – Car, truck, boat, RV
- Investments – Stocks, bonds, mutual funds
- Valuables – Jewelry, art, collectibles
Collateral loans come in many forms. For instance, mortgages and auto loans are types of collateral loans. The property purchased with the loan acts as collateral. Other examples include pledging real estate for a home equity loan.
How Do Collateral Loans Work?
Collateral loans involve a process to protect the lender and borrower:
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The lender assesses the value of the collateral to ensure it sufficiently covers the loan amount. Real estate requires an appraisal.
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The borrower provides proof of collateral ownership and value when applying.
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If approved, the lender places a lien on the collateral. This gives them the right to take the property if the borrower defaults.
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The borrower makes regular payments over the loan term. When the loan is fully paid off, the lender removes the lien.
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If the borrower defaults, the lender can seize the collateral through foreclosure or repossession and sell it to cover the unpaid balance.
What Property Can Be Used as Collateral?
Lenders accept various property types to secure a loan. Common options include:
Real Estate
Real estate, including your house, land, or commercial property, often makes ideal collateral. Lenders can place a lien against the property’s title. Real estate tends to hold value, making it low-risk collateral.
You can use real estate as collateral in several ways:
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Mortgage – The home being purchased serves as collateral for the mortgage loan.
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Home Equity Loan – Your existing home’s equity can be collateral for a home equity loan or line of credit.
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Land Loan – Undeveloped land can be collateral for purchasing the property.
Vehicles
Cars, trucks, motorcycles, boats, and other vehicles also get used as collateral for loans. The vehicle’s title has a lien until you repay the loan.
Common collateral vehicle loans include:
- Auto loans
- Boat loans
- RV loans
- Motorcycle/ATV loans
Lenders often require collision insurance coverage for the duration of vehicle collateral loans. Otherwise, damage or destruction of the vehicle could result in default.
Securities
Investment accounts like stocks, bonds, and mutual funds can collateralize a loan, usually through a securities-backed line of credit. The investments act as collateral, allowing you to borrow against their value.
The lender places a lien on the securities and can liquidate them if you default. One risk is market volatility causing decreases in the collateral value.
Valuables
Items like jewelry, artwork, antiques, and collectibles can be used as collateral, typically for pawn loans. However, lenders may assess these items conservatively, lending only a portion of the estimated value.
The lender takes possession of the item for the loan’s duration. You regain ownership when repaying the loan. Defaulting results in forfeiture of the collateral.
Benefits of Using Property as Collateral
Using property as collateral provides key advantages:
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Better Loan Approval Chances – The collateral reduces lender risk, increasing approval odds for borrowers with lower incomes or credit scores.
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Higher Loan Amounts – Providing collateral allows borrowing larger loan amounts than permitted for unsecured loans.
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Lower Interest Rates – Collateral loans often have lower interest rates due to the reduced risk.
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Access Home Equity – Collateral lets homeowners tap into accumulated home equity for financing.
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Buy Raw Land – Undeveloped land purchases require collateral to get financing.
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Consolidate Debt – Collateral can secure loans for consolidating high-interest debt.
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Quick Access to Cash – Collateral loans allow fast access to funds in an emergency.
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Build Credit – Making on-time collateral loan payments helps improve your credit history.
Risks of Using Property as Collateral
While beneficial, collateral loans also come with drawbacks to consider:
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Losing the Collateral – Defaulting results in the lender taking possession and selling the property to recover loan losses.
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Longer Approval Times – Collateral loans require more extensive processes to verify ownership and value.
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Lower Loan-to-Value Ratios – Lenders may lend only a portion of the collateral’s appraised value.
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Declining Collateral Value – Market changes could decrease your collateral’s worth below loan balances.
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Costly Appraisals – Lenders typically require real estate appraisals at your expense to assess collateral value.
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Prepayment Penalties – Some collateral loans impose fees for early repayment of the loan.
Weigh these pros and cons carefully when deciding whether to use property as collateral. The risk of losing a valuable asset you pledge is substantial. Make sure the loan terms and property protection measures appropriately match your situation.
What Are the Steps to Use Property as Collateral?
If you decide a collateral loan meets your needs, follow these key steps:
Have Your Property Appraised
Lenders require current property valuations to verify sufficient equity and set loan amounts. Real estate appraisals are standard for mortgages and home equity loans. Expect to pay $300-$500 or more depending on the property value and location.
Research Lenders
Compare loan offers from banks, credit unions, online lenders, and other sources. Check interest rates, fees, loan amounts, and terms. Ask about their specific collateral requirements.
Submit a Loan Application
Provide your personal and financial information to apply for the loan. Supply required income and credit documentation. The lender will formally assess your creditworthiness.
Close on the Loan
If approved, you’ll sign final loan documents and the lender will place a lien on the property’s title. The appraised collateral value must be sufficient to proceed.
Make Payments on Time
Stay current on your loan payments to avoid default. If financial hardship arises, immediately contact your lender to discuss alternatives before missing payments.
Alternatives to Collateral Loans
Other options may meet your needs without pledging collateral:
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Unsecured Personal Loans – These loans rely on creditworthiness rather than collateral. Amounts up to $40,000 are possible for those with good credit.
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Borrower Partners – Adding a creditworthy co-signer may help you qualify and get better terms. The co-signer and their income get considered.
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Credit Card Financing – Many expenses can get charged to credit cards. Reward cards provide additional value on purchases.
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Home Equity Loan Alternatives – Consider cheaper alternatives like cash-out mortgage refinancing to access home equity without a second lien.
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Debt Management Plans – Credit counseling services can negotiate lower interest rates and payments on existing debts to avoid new collateral loans.
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401(k) Loans – Borrowing against your 401(k) avoids collateral risk. However, it reduces retirement savings and you repay the loan with after-tax money.
The Bottom Line
Using property as collateral for a loan enables borrowing larger amounts and getting better terms. However, the risk of losing pledged assets makes thorough financial evaluation important. Collateral loans work best for those with limited alternatives who understand the hazards involved. Otherwise, less risky options like unsecured loans or credit cards may better suit your needs.
Cons Of Collateral Loans
Collateral loans also involve the following drawbacks:
- Risk of losing asset: Collateral is a safety net for lenders when borrowers fail to repay the loan. In these cases, the borrower loses the asset securing the loan.
- Longer approval period: Collateralized loans involve a more intensive approval process because the lender evaluates the asset securing the loan. As a result, borrowers in a pinch might find a secured loan to move too slowly for their needs.
What Are The Pros And Cons Of Collateral Loans?
Collateral loans have advantages and disadvantages for borrowers to be mindful of.
Collateral Loan Tips
FAQ
Can you use property as collateral for a loan?
How much can I borrow using my home as collateral?
What is a required property to be used as collateral?
Can I get a personal loan using my house as collateral with bad credit?