What Are Collateral Loans?
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Loans can be either secured or unsecured. Secured loans, also known as collateral loans, require you to pledge an asset, like a savings account or car title. By comparison, unsecured loans don’t require collateral.
Offering an asset as collateral could help you qualify for a lower interest rate or higher loan amount. But this comes with significant risk, as a lender can seize your collateral if you default on the loan.
Here’s what you should know about collateral loans, including how they work, benefits and drawbacks, and where to find them.
What are collateral loans?
A collateral loan is secured by an asset, something of value you own. You can use several types of collateral for a loan, most commonly the deed to your home or the title to your car. But items like a certificate of deposit, or CD, account or an expensive and rare piece of art on your wall can also be used.
Collateral loans often have higher loan amounts and lower interest rates than unsecured loans, such as most credit cards and personal loans. If you have minimal credit history or your score’s not so great, a collateral loan can be easier to qualify for than an unsecured loan.
How they work
When you apply for a secured loan, a lender assesses the value of your collateral to determine your loan amount. For example, if you take out a home equity loan, a lender bases the loan amount on a percentage of your home’s equity. If you fail to repay the loan as agreed, a lender can take your collateral.
Types of collateral loans
Several types of collateral loans exist, including:
- Mortgages. With a mortgage loan, your home serves as collateral. If you default on the loan, a lender can take your home.
- Home equity loans. When you take out a home equity loan, the collateral is the equity in your home. Not repaying a home equity loan on time could lead to losing your home.
- Car loans. A car loan is secured by your vehicle. If you default, a lender can repossess your vehicle.
- Car title loans. A car title loan is a secured-short term loan that, as the name implies, uses your car’s title as collateral. Like a car loan, a lender can take your car if you fail to make on-time payments.
- Secured personal loans. Although personal loans are usually unsecured, some lenders offer secured personal loans. A savings account or other type of asset can secure this type of loan.
- Pawn shop loans. Pawn shop loans are secured short-term loans. You can use many valuable possessions as collateral, including electronics, jewelry, or firearms.
Who offers collateral loans?
You can get a collateral loan from several types of lenders, such as:
- Banks. Many banks offer secured loans — and if you have an existing relationship with them, the bank may reduce your interest rate by 0.25 percentage points or more.
- Online lenders. While many online lenders only offer unsecured loans, some offer secured loans. For example, one lender offers personal loans secured by your home’s fixtures.
- Credit unions. Because credit unions are member-owned, not-for-profit institutions, you may be offered a lower rate than an online lender or traditional bank.
- Car dealerships. You can choose to finance a vehicle through a dealership. But compare rates from outside lenders to ensure you’re getting a fair deal.
- Pawn shops. Many pawn shops offer secured loans, but high fees and interest rates make these short-term loans expensive.
How to get a collateral loan
The application process varies, but here are the general steps you take to apply for a collateral loan:
- Review your credit. Credit score requirements vary by lender. Before you apply for a collateral loan, check your credit score. Also, review your credit reports for inaccuracies from all three credit bureaus — Equifax, Experian, and TransUnion — by going to AnnualCreditReport.com. There, you can check your reports for free weekly.
- Compare lenders. Prequalify with as many lenders as possible to get an idea of rates and terms you might receive. Next, compare rates, terms, and collateral requirements for any offers you receive to find the best fit.
- Submit a loan application. After you choose the lender that best matches your needs, apply online or in person. Lenders generally require you to provide information such as your Social Security number, tax returns, W-2s, and paystubs.
- Review and sign the loan agreement. If you qualify, a lender will send you a loan agreement. Review this agreement carefully to see if you agree with the loan’s terms before signing.
- Repay your loan as promised. Once you receive your funds, repay your loan on time to avoid paying late fees, losing your collateral, and damaging your credit. Enroll in autopay, if possible, to avoid missing payments.
Benefits and drawbacks of collateral loans
Collateral loans, like all financial products, have pros and cons that need to be weighed carefully.
Some potential benefits of collateral loans include:
- Can be easier to qualify for. Lenders view secured loans as less risky because they can take your collateral to satisfy the debt if you default. As a result, you may have an easier time qualifying for a secured loan if your credit profile is light or your score is on the lower end.
- Can help you establish or rebuild credit. If you don’t have any credit history or your credit has been damaged, taking out a secured loan could help you add positive payment history to your credit reports, which could help you achieve a higher credit score.
- Potential lower rates. Collateral loans tend to come with lower interest rates than unsecured loans, which could potentially save you a lot of money.
- Higher loan amounts. Depending on the value of your collateral, a lender may offer you a bigger loan.
While pledging collateral can help you secure a lower rate, consider potential cons.
- Can lose your collateral. If you fail to repay your loan as promised, a lender can seize your collateral. For instance, if you fail to repay your mortgage, a lender can foreclose on your home.
- Assets needed. If you don’t have any assets to pledge, you’ll have to consider alternative options.
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