Collateral Loans – What Are They and How Do They Work?
Trevor Mahoney is a financial services writer and content creator based out of Los Angeles, California. He holds a Bachelors of Science in Finance from Santa Clara University. In his free time, he enjoys hiking and lounging on the beach.Read full bio
At a Glance
Of the many different loan types available to borrowers, collateral loans are commonly seen. For some, a collateralized loan can offer many crucial financial benefits. Covering the ins and outs of a collateral loan will help you to determine whether this is the right loan for you.
In this article, you’ll learn:
- What is a collateral loan?
- How do collateral loans work?
- Types of collateral loans
- Collateral loan rates
- What can you use as collateral?
- Pros and cons of collateral loans
- Where can you find loans with collateral?
- How to apply for a loan with collateral?
- What happens if you don’t repay your collateral loan?
- Collateral loan alternatives
What is a collateral loan?
A collateral loan is a term often used interchangeably with secured loan. It is a loan type where the asset you have taken out is backed by something of value that you own. Examples of secured loan types where collateral is involved include auto loans, mortgage loans, boat loans, insurance policies, and more.
A collateral loan will usually come with a lower interest rate than a loan where the collateral is not involved. This is because, due to the fact the loan is secured by an asset, there is less risk for the lender. The lender can then feel more comfortable offering a lower interest rate, and the odds of approval may also be higher for those with lower credit scores or poor histories.
How do collateral loans work?
A collateralized loan obligation works in much the same way as any other loan. You approach a lender seeking to borrow some type of asset. When going through this process, you will need to present the asset you wish to put up as collateral. Some types of loans will demand a certain type of asset, whereas others will allow you to choose.
After selecting the necessary collateral, the lender will determine your loan amount by considering the value of your collateral. As a note, your loan amount will never exceed the total value of that collateral. Once you are approved for the loan, you will be provided with whatever asset you wish to borrow and can begin repayments.
Types of collateral loans
There are several different types of collateral loans where different collateral will be expected by the lender. Learning these different types can help you make a more educated decision on which is right for you:
1. Secured personal loan
Perhaps the most common type of collateral loan, a personal loan with collateral will allow you to borrow, typically anywhere from $1,000-$100,000 depending on the value of your collateral. With good credit, secured personal loan rates may be as low as 3%, but with poor credit, they may be as high as 36%.
Secured personal loans are structured simply with a monthly payment that includes interest, fees, and other associated expenses with the repayment.
Related: Secured vs. Unsecured Personal Loans
2. Home equity loan
A home equity line of credit (HELOC) is another common type of loan that is collateralized. Home collateral loans allow you to borrow money with a portion of your mortgage as collateral. When determining how much to let you borrow, a lender considers the following factors:
- Appraised value of the home
- Amount of mortgage left remaining
- Borrowing amount requested
Should your home be appraised for $300,000 and there is $200,000 remaining on the mortgage, your line of credit would not exceed $100,000 (the portion you have paid). A lender may only choose to offer you a percentage of that portion as well based on factors such as credit, income, and more.
Related: Home equity line vs HELOC
3. Auto loan
Car collateral loans are another one of the most common types of collateral-based loans. When you go to a dealership and purchase a vehicle, in most cases, the car you are planning to buy is the collateral on the loan amount you borrow. This means that if you stop making payments on the vehicle, the dealership can repossess the vehicle you purchased.
It is also possible to take out a personal loan with a portion of your car title serving as collateral. In this situation, the vehicle must be fully paid off and, in your name, to go through.
A mortgage loan works similarly to a HELOC, but rather than your portion of the mortgage being collateral, your entire home is the collateral. This is typically reserved for larger loan amounts given that the borrower needs to have fully paid off their home prior to borrowing. The danger with mortgage loans is that, assuming you fail to meet your payments, you risk foreclosure on your home and the loss of the property.
5. Margin trading
Stocks as collateral loans are a unique type, but they do exist. This occurs when an investor wishes to borrow money from a borrower to purchase shares, and the amount in the investor’s brokerage account serves as the collateral. Should the shares fall in value, the broker can demand repayment for the lost money if it exceeds the value of the portfolio.
6. Loan against securities
For general collateral loans, using shares, mutual funds, ETFs, bonds, and more are allowed forms of collateral for many lenders. Depending on the total value of these assets, the total value of the loan amount will change. Should the value of this collateral go down over time, the lender will expect the borrower to return more cash to cover the loss in value.
Collateral loan rates
Collateral loan rates vary depending on the type of loan, but it is not uncommon to see the following with good credit:
- Mortgage loan : 3%
- HELOC : 3% – 10%
- Car loan : 4% – 15%
- Car title loan : 25%/month
- Personal loan : 3% – 36%
What can you use as collateral?
Items that can be used as collateral vary but are typically anything you own of significant value. The most common examples of collateral for a secured loan include:
- Savings account
- Other real estate properties
- Insurance policies
- A boat
The above are just examples of what a lender may allow. When considering an online or bank loan with collateral, ask your lender what types of collateral are allowed or required.
Pros and cons of collateral loans
As with any type of loan, there are several pros and cons for a loan with collateral:
Determining whether a collateralized loan is right for you involves looking at the purpose of the loan, what type of assets you have as potential collateral, and the above pros and cons.
Where can you find loans with collateral?
Lenders who offer traditional unsecured loans will likely offer loans with collateral as well. Online lenders will typically offer collateral loans online, banks may offer collateral personal loans or collateral loans on property, and some credit unions may offer collateral loan types as well. Regardless of which lender type you choose, be sure you have the ability to repay the collateral based loan.
How to apply for a loan with collateral?
The process of applying for the best collateral loans is simple:
- Determine the loan amount you need by evaluating the purpose
- Research different lenders and read what can be used as collateral for a loan
- Prequalify for as many offers as possible to see what interest rates are offered
- Compare offers
- Gather all necessary income and personal related documents
- Receive approval or denial
- Begin repayments if approved
Keep in mind that failure to meet payment can quickly result in the collection of your collateral on behalf of the lender. In the event you are going through financial hardship and believe you may miss a payment, speak with your lender to see if they allow any leniency on the due date.
What happens if you don’t repay your collateral loan?
Whether it’s a business loan with collateral, collateral loans on vehicles, or personal loan collateral, going into default on that loan is risky. Many lenders allow a 30-day grace period after a missed payment where the loan is qualified as delinquent, rather than in default, meaning that you can still make up the missed payment.
However, if the loan enters default, then you are at risk of losing whatever item you put down as collateral. The collection process varies depending on the collateral type.
Collateral loan alternatives
If you’ve decided offering collateral for a loan isn’t for you, there are a few potential alternatives to consider depending on your income, credit level, and other factors:
- Unsecured personal loan: This is the exact same as a secured personal loan except there is no collateral involved. Given this, it is more difficult to get approved for these loans and the interest rate can be higher.
Compare: Best Personal Loans
- Borrowing from friends and family: If the loan amount you’re seeking is on the smaller side and you don’t want to risk losing an asset, consider asking a trusted friend or family member who may be willing to help.
Collateral loans certainly come with risk considering you stand to lose the asset you are putting up as collateral. However, if you are certain you can make all repayments on-time and in-full without hindering your financial standing, collateral loans can be excellent ways to secure lower interest rates and higher borrowing amounts.
Collateral loan bad credit opportunities do exist, but they may come with higher interest rates. By default, a secured collateral loan bad credit or good credit opportunity will typically be an easier approval than an unsecured loan. However, having bad credit can possibly indicate a poor history with credit and debt repayment. If this is the case, consider working on raising your credit score before borrowing.
Yes, a vehicle can be used as a form of collateral in two types of loans: auto loans and car title loans. An auto loan is a vehicle collateral loan where the car you are purchasing is the collateral itself. A car title loan is when you already own the vehicle and paid it off fully, and you put a portion of the value of that car up as collateral for a loan.
Yes, stocks can be used as collateral on a loan. Keep in mind, though, that if the value of those stocks’ plummets, so does the value of your collateral. In this situation, the lender would expect you to come up with cash to replace the value of the collateral that has been lost.