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What Is Personal Loan Collateral?
A collateral is an asset with a financial value used for secured personal loans. The main idea behind this is that if the borrower fails to honor its debt obligations at some point, a bank or credit union has a right to take possession of the asset.
To better understand how it works, it is helpful to point out that there are two types of personal loans, each with its characteristics.
With both types of loans, the bank or some other financial institution analyzes the credit rating, sources of income, payments history, and a debt-to-income ratio of the individual to determine whether or not to approve a loan application.
Which Type Of Loan Require Collateral?
When it comes to unsecured loans, no collateral is involved in the loan agreement. Consequently, if a borrower fails to keep up with payments, the bank does not have collateral to fall back on.
As a result, the typical interest rates on unsecured loans are higher than on secured loans. In this case, most banks might have stricter credit rating requirements.
However, when it comes to secured personal loans, the borrower agrees to use some asset as collateral, such as a home, vehicle, savings account, or some other asset with value. So if the borrower fails to make payments at some point, the financial institution can sell the collateral to compensate for the loss.
As a result, it is easier to get approved for a secured loan in most cases, and interest rates are also generally lower than unsecured loans.
Items To Use As Collateral For A Secured Loan
So, what types of assets can you use for collateral? Well, according to Experian, one of the three major credit rating agencies in the US, banks are looking for liquid assets that are worth no less than the value of your personal loan.
Here are some of the assets banks usually agree to take as collateral:
- Commercial properties
- Money market accounts
- Savings accounts
- Certificates of deposit (CDs)
- Life insurance policies
- Mutual fund investments
- Stock investments
- Bonds investments
- Precious metals, such as gold and silver
As we can see the list of assets that can be used for collateral is quite large. Remember that if you pledge any asset as collateral, you can not sell it without paying off the loan.
So, for example, if you pledged your home or commercial property, you can not transfer the property to a new buyer unless you pay off the bank or credit union loan.
In the case of certificates and deposits, money market accounts, stock and bonds on your investment accounts, and other financial assets, you can still earn interest or dividends on those accounts. However, you can not withdraw and spend those funds until the personal loan is paid off.
Do You Need Collateral For A Personal Loan?
At this point, it is worth mentioning that collateral is not required for all personal loans. As a result, banks issue billions of dollars worth of unsecured loans each year.
However, there are some scenarios where getting a secured personal loan might be necessary:
- Average or poor credit rating – You might have difficulty getting approved for unsecured loans due to having an average or poor credit rating. One way to deal with this problem and increase the chances to get approved is to come up with collateral to get a secured loan.
This does not automatically guarantee that you will get approved for a personal loan. However, this can improve your chances of approval considerably.
- Looking for low-interest loans – You might qualify for unsecured loans, but if getting the lowest rate possible is your priority, you might consider getting a secured loan. The fact is that banks and credit unions typically offer lower interest rates on secured loans.
This is because, in this case, they have to take on much less financial risk when lending you money. As a result of lower rates, you can also save considerable money on interest.
Using Collateral On Your Personal Loan: Pros And Cons
Just like any other financial decision, using collateral to secure a personal loan, does have a number of advantages and drawbacks.
Here are the main pros and cons to consider:
Limited Loan Amount
Risk of Losing Collateral
The approval process for secured loans is usually relatively easier compared to unsecured loans.
This is not surprising since bankers know that, in this case, even if you fail to meet your debt obligations, they can take possession of your collateral to make up for the potential losses.
Therefore, banks and credit unions might not be as demanding about your credit score as in other cases. Of course, this does not guarantee a 100% approval rate, but it can improve your approval odds.
Since banks face less financial risk with a secured loan, they are also likely to offer lower interest rates on personal loans.
For example, if we use a loan calculator, on a $25,000 3-year loan with an 8% interest rate, the monthly payment will be $783. On the other hand, if the interest rate is 12%, then the monthly payment will be $830. That is $1,697 more interest you have to pay during those three years of loan repayments.
There are no standard interest rates on secured loans, and each bank has its policies, but the above example illustrates that interest rate differential can add up to a significant
If you need a secured loan, it means your credit is not the best. Leverage your personal loan to build credit.
It is worth remembering that in the case of secured loans, the maximum loan amount depends on the value of an asset used as collateral.
So, for example, if you use your $5,000 certificate of deposit to secure a personal loan, you can not borrow more than that $5,000. Some banks and credit unions would prefer to loan you 80% to 95% of the value of collateral to leave some room for fees and other expenses.
In the case of real estate, they do this as an insurance policy in the case of falling property prices.
The most obvious disadvantage of using collateral on your personal loan is that there is always a risk that you might lose it. On the other hand, you might never have any trouble making payments and eventually pay off your debt in full without any complications.
However, this is not 100% guaranteed. For example, you might face unexpected financial difficulties and be unable to make payments. In this case, the bank or credit union has a right to take possession of your collateral.
So if you do not want to take on such a risk, looking for a secured loan might be a better option.
In the case of secured personal loans, banks and credit unions have collateral to take possession of, if your fail to keep up with the agreed payment schedule. They can sell that collateral to recover lost funds.
As a result, banks take on less financial risk with secured personal loans, and therefore, their requirements to their clients for getting such a loan are not as strict as when it comes to secured loans, even if you're looking to
Not all personal loans require collateral. Personal loan for good credit usually doesn't require this. This is not 100% guaranteed, but the odds might be favorable.
Consequently, in this case, you do not have to come up with any collateral to secure a personal loan.
Mortgage lenders, whether it will be banks or credit unions always ask for some type of property to be collateral.
With personal loans, any financial institution can ask you for collateral, if they see lending money to you as risky, or if the amount is too large from their point of view.
Not all banks accept jewelry as collateral. However, some of them do. Those banks who accept them as collateral usually call in the services of an appraiser, who can analyze the jewelry in question and tell them how much it can be sold at the market.
They can then use this information to determine the maximum amount of secured personal loans.
Some lenders require the collateral to be equal to the loan amount. However, it is worth keeping in mind that there are also some financial institutions that require the value of collateral to be higher than the loan amount.
They might do this as a sort of insurance policy. For example, if you use your gold holdings as collateral and then the gold price drops, they can still recover their money if at some point you default on your debt obligations.
Getting a personal loan with bad credit can always be a challenging task. However, if you have collateral, then there can be some banks or credit unions, who might agree to approve your secured personal loan application.
A good credit rating is always helpful with any loan application. However, with most banks, this is not mandatory for issuing secured loans.