We recently dove into the difference between secured and unsecured loans
and discussed how secured loans require collateral. Now, let’s take a deeper dive into exactly what collateral is, and what should be used as loan collateral if you have the option to negotiate it.
What is Collateral?
is anything of value that a lender accepts as security for a loan. Common examples include a home being used as collateral for a mortgage loan
and a car being used as collateral for an auto loan
. If a borrower defaults (or fails to make payments) on a collateralized loan, the lender is legally allowed to seize the collateral and sell it to recover part or all of the loan balance. The collateral at stake will be agreed upon when you take out a secured loan and should be written in the contract.
The claim that a lender has on your collateral is known as a lien
. If a loan does not require collateral, it would be an unsecured loan. Failure to repay an unsecured loan would not result in a seizure of property, but it would likely result in late fees, interest charges, and in some cases, debt collection.
What Can Be Used as Collateral?
The most familiar types of collateral are motor vehicles and real estate. Homes and property are used to collateralize mortgages
, home equity loans
and home equity lines of credit
(HELOCs). However, anything that can be sold for profit can potentially be used as collateral. Other items
that could potentially be used as loan collateral include:
- Computers and other tech devices
- Valuable art and precious metals
- Collectible items
Financial assets can be collateral as well. For example, a collateral loan
may be secured by a cash balance in a bank account for the amount of the loan. A secured credit card is another type of secured loan that uses a financial asset as collateral. A secured credit card
requires a cash deposit from the cardholder in order to secure the credit line. A collateral loan or secured credit card can be a good option for those looking to repair or establish credit
. In some cases, an investment account
may be used as loan collateral as well. For example, an investor might borrow against their current holding of stocks and bonds in order to buy more. Collateral is also a common requirement for business loans, with many businesses using their inventory or business equipment to secure their loans.
When Do I Need to Put Up Collateral?
With some loans, collateral is always required. For example, regulations require that a mortgage be secured by the property. No lender is going to issue an auto loan
without the vehicle as collateral.
Beyond that, collateral is required any time a lender wants to ensure that the loan will be repaid. For a borrower with bad credit or without much credit history
, a secured loan is usually the only option. Even if an unsecured loan is available, it sometimes makes sense for the borrower to offer collateral. One reason is that secured loans generally have higher borrowing limits and lower interest rates than their unsecured counterparts.
As mentioned previously, a collateralized loan or secured credit card can also be a way for a borrower to build or repair their credit history
. After a length of time making successful payments on a secured loan or credit card, a borrower can usually raise their credit score
to the point that they’ll eventually qualify for an unsecured loan or regular credit card.
What Is the Difference Between Collateral and a Personal Guarantee?
While collateral is something of value that the borrower puts up in order to secure a loan, a personal guarantee
is a promise
to repay the loan. In some cases, a loan with a personal guarantee may also be secured by collateral. A personal guarantee allows the lender to take action to recover their money in the event the loan is not paid back. With a personal guarantee a lender can potentially sue the guarantor, withdraw from their bank accounts, garnish wages, or go after their assets in any way allowed by law.
A guarantor can be the person actually borrowing the money, or it can be a co-signer
. In some cases, the guarantor can even be an organization. Many government loans are guaranteed by specific government organizations. For example, a VA loan
is backed by the U.S. Department of Veteran Affairs, while an FHA loan
is backed by the Federal Housing Administration.
While personal guarantees are typically more common with business loans and government-backed loans, they can be used in some cases for personal loans
When taking out any type of loan, it is important to work with your lender to be sure you have a full understanding of the terms and conditions involved. Even if it seems like a straightforward scenario, don’t be afraid to ask questions so you feel confident with your loan agreement. If you’re looking for a home loan
, car loan
, collateral loan,
or unsecured personal loan
, don’t hesitate to contact us