If you plan on taking out any sort of loan in the near future, you might need to use an asset as collateral. If the idea of using something like your house or car to secure a loan raises a few questions, you’ve come to the right place.
In this article, we’ll look at the differences between secured and unsecured loans. Additionally, we will discuss the different types of assets that you may be able to use to secure a loan, as well as the benefits of taking out collateral loans.
Understanding Secured vs. Unsecured Loans
When a bank lends money, their number one concern is repayment of the loan. Lenders want to ensure that a borrower is able to repay the money that they borrow. Banks assess the risk of a loan by looking at a number of things— the borrower’s income, debt, and history with borrowing money.
They also consider whether or not the borrower is putting up any collateral for the loan. In short, collateral is an item of value that a financial institution can seize if the borrower defaults or fails to repay their loan according to the terms.
Loans that require borrowers to offer a collateral asset are known as secured loans. Unsecured loans, on the other hand, are not backed by a collateral asset.
Examples of secured loans include:
- Home equity loans and home equity lines of credit
- Auto loans
- Some personal loans
Common unsecured loans include:
- Student loans
- Some personal loans
Traditional credit cards are also often considered a type of unsecured loan.
How Collateral Loans Work
Say, for instance, that you take out a personal loan and use your vehicle as collateral. In exchange for financing, you promise the title to your car should you default on the loan.
In other words, if you were to stop making payments, the lender would have the right to seize the vehicle and sell it to recoup their losses.
Of course, financial institutions aren’t going to repo your car the second you miss a payment. Going through the legal hoops takes time— and money— so it’s often a last resort for banks. Most lenders would much rather work with the borrower to adjust the payment schedule or loan terms. It’s always important to communicate with your lender if you are having trouble making payments, as they can help you find a solution that doesn’t involve losing your collateral asset.
Collateral Assets that You Can Use to Secure a Loan
So what, exactly, can you use to secure a bank loan? There are actually numerous types of collateral that financial institutions may accept.
Keep in mind that many loans— such as home loans— require you to use the asset that you are financing as collateral. You could not, for example, use your car to secure your home mortgage.
Your home is one of the most common assets used to secure loans. Most commonly, real estate is used as collateral for mortgages, home equity loans, home equity lines of credit, and larger personal loans. If you are a business owner, your home can even be used as a personal guarantee on a small business loan.
If you have an auto loan, chances are it’s secured by the automobile that it is financing. Cars and trucks, as well as other large recreational vehicles like RVs or boats, may also be used as collateral on personal loans.
If you have limited credit history or are recovering from a financial downturn, your credit union can help you secure a good loan rate based on your available funds. For example, if you currently have cash in a checking or savings account, you may qualify for a share secured or share certificate loan. A share secured loan is an ideal option for those who want to build their credit by making regular payments and use their available cash as collateral.
Some financial institutions will allow you to use investments such as stocks or bonds as collateral for some types of loans.
Other Personal Belongings
In specific cases, valuable belongings like jewelry, precious metals, fine art, or collectibles may serve as collateral. Please note: this is a unique type of collateral, and typically involves belongings of extraordinary value.
Benefits of Using Assets as Collateral
Using collateral assets to secure a loan has some great benefits. In general, the advantages to secured loans include:
- They come with a lower interest rate: A lender will typically offer better interest rates on secured loans.
- They are easier to qualify for: If you have less-than-stellar credit or fail to meet certain eligibility criteria, putting up collateral can help you qualify.
- You can take out larger loans: Large loans often require collateral. If you are unable to borrow the funds you need with an unsecured loan, using a collateral asset will give you more options. For instance, if you own your home outright, you can borrow 80% of your home’s value with a home equity loan.
- You can put your asset to work: If you have a large asset that is worth money, that money isn’t exactly “liquid”. A secured loan can help free up that worth for other purposes.
Because collateral-backed loans are less risky for a lender, borrowers get a better deal and more options overall. Unsecured loans will typically have higher interest rates and will have more stringent credit requirements.
Though they have great benefits, you should be prepared for collateral loans to take a little longer to process than unsecured loans. Oftentimes, banks must appraise the value of your asset, which may take extra time.
Taking Extra Caution When Putting Up Collateral
Using assets as collateral comes with a lot of benefits— but it’s important to be aware of the one major downside of secured loans. If, for whatever reason, you aren’t able to repay your loan, you may end up losing your collateral asset. Again, this is typically the last resort for a lender, but it does happen. This can be a particularly bad situation if the lender forecloses on your home. Not only can you lose the house that you live in, but it will leave a nasty mark on your credit report for years to come.
Explore Your Loan Options
Whether you use assets as collateral or not, taking out a loan can be a big decision. Always make sure to research your options thoroughly before signing on the dotted line. Not sure what financial product is best for you and your finances? Talk to a loan officer at Amplify Credit Union for recommendations on the best product for your unique situation.