An illustration well answers the question, what is a collateral loan? Imagine you are in a tricky situation, and you badly need financial assistance. Your immediate family members or friends are the first people to contact. But, what if you need more cash than your friends or family can afford to raise? The solution would be to take out a collateral loan.
Collateral is property or any other asset you would offer to a lender to secure a loan. When you borrow money in a formal institution, you agree, in writing, to pay it back. Details on what is a collateral loan, its pros and cons, and how to secure a collateral loan from a lender are well described in this article.
The Concept of a Collateral Loan
History of lending is not well documented, but its believed to have begun thousands of years ago. First forms of collateral loans appeared as indentured loans. Poor laborers borrowed against the promise of their services. Wealthy landowners used to borrow money against their property.
Collateral loans are applicable in most fields. From automobiles loans, real estate mortgage loans, advertisement loans using consumer products as collateral, the list is endless. The purpose of these loans is to benefit from a line of credit without actually having to sell your assets.
Today’s small business or individual collateral loans work pretty much as traditional loans. First, you make a formal application for the loan. Next, you are required to submit the necessary documentation showing proof of ownership of the asset you pledge as collateral. After verifying the documents, the lender approves the loan.
From approval, the paperwork begins. You have to agree, in writing, the amount you would wish to borrow and a defined payback period. When all the paperwork is done, the lender credits your account with the agreed funds. Breach of any of the terms of the agreement results in forfeiture of the asset.
Collateral implies to the lender assuredly that they will not lose all their money. Should you default payments or breach the written agreement in any way, the lender has the right to assume possession of your collateral.
Advantages and Disadvantages of Collateral Loans
A variety of collateral loans are available, and each has its pros and cons. Any asset your lender accepts may be collateral, and is not limited to fixed assets only. Insurance policies, investments, future payments and cash accounts may suffice.
Collateral assures you higher amounts of money, but the risks are also high. Cases of home, vehicles and other asset repossession by lenders are not uncommon. On the brighter side, you may have heard of people who built great businesses with secured loans. To help you make an informed financial decision, we have researched and compiled a detailed comparison of the pros and cons of collateral loans.
Advantages of Collateral Loans
1. What is a collateral loan average credit score? Not important. While a poor credit rating may be challenging to secure a personal unsecured loan, collateral and proof of ownership are all you need to borrow secured loans. However, lenders do not entirely ignore poor credit ratings. A higher interest is imposed on the approved loan. Collateral loans may be used for any legal expenditure.
2. What is a collateral loan payback period? The period over which secured loans periodic payments are spread. While personal loans only last a few months, secured loans can be paid over more extended periods. Some get up to 10 years. The periodic payments are spread over that extended time, and therefore do not have any drastic effect on your monthly income.
3. The secured loan has lower interest rates. Unsecured loans are paid over shorter periods and have exorbitant interest rates. However, lenders are not in a hurry to reclaim funds from secured loan borrowers. The collateral is assurance of getting their money back. As a result, lenders impose a lower interest rate to these types of loans.
4. Regular collateral loan borrowers will find these loans very convenient. Your lender will always be happy to give you a collateral loan especially if you pay on time and you have an excellent credit rating. The feature is recommended for borrowers who use their savings as collateral since not much real valuations are involved compared to asset pledges.
Disadvantages of Collateral Loans
1. Loss of assets or property is not uncommon for collateral loan borrowers. Mortgage loan borrowers end up losing their homes if they default payments. The case is the same for other collateral loan borrowers who pledge other assets. Breach of the agreement always results in forfeiture of the asset.
2. Collateral loans are often considered a solution to massive debts problems. An expert may advise you to “consolidate” your huge debts and then take out a collateral loan to pay off all the debts. On the brighter side, this is a way to benefit from a low-interest rate on the secured loan. However, that solution may be a grave danger lurking. In the event you are unable to pay back the loan, you may end up losing everything you have ever worked for.
3. What is a collateral loan interest rate? Variable interest rates that are dependent on prevailing economic conditions. Unsecured loans are independent of the prevailing economic conditions and have fixed rates. Variable rates are considered very risky especially in times of economic downturns. Lenders will always ensure their profits are not hurt and will always transfer losses due to inflation to their customers. As a result, you may end up paying higher interest on the collateral loan than you had anticipated creating unnecessary expenses.
4. Secured loan borrowers who pledge assets as collateral incur upfront expenses before their funds are processed. Valuation costs, document submission and verification costs, transportation costs to and from the property are unnecessary expenses imposed on the borrower.
5. What is a collateral recommended usage? Secured loans should be used for investments or paying off debts. Buying household items or other “white goods” will leave you in debt long after the expiry of the item. Refrain from borrowing a collateral loan to buy depreciating items.
6. Mortgage loan holders, taking out a collateral loan rather than remortgaging is not recommendable. The new credit will only make you miss out on exclusive rates presently enjoyed on the existing mortgage loan. Similarly, changing your mortgage with the intent to get extra money exposes you to early repayment expenditure. Moreover, requesting additional funds by remortgaging may have restrictions on usage.
The article fully answers the question, what is a collateral loan? However, it’s important to end by saying that collateral loan features are not all the same among the different lenders. Due diligence is important before you borrow from a particular lender. Compare loans features among different lenders and borrow from the best. Also, you do not have to take out a collateral loan if you have qualified for an unsecured personal loan. If you have a good credit rating, take out the unsecured personal loan and payback in time. You will secure funds without having to risk your property or assets. With this information in hand would advise a needy friend to take out a collateral loan.
You might also like: What Is an Unsecured Loan?
Logan Edwards says
It got me when you said that collateral loans are really helpful, but they are also a bit risky since repossessions of cars and houses are also common. If that is the case, if I ever decide to go for this, I have to be sure that I will get what I placed as a collateral back to me. Anyway, I will keep this as another option since I need to renovate the house, and I need the money to do it. I will have to try this loan and give my car if I really didn’t have a choice.
Kevin Monk says
We hope our article has managed to answer at least a few of the questions you had about collateral loans. They can definitely be risky, so you have to consider all the advantages and disadvantages before deciding on one. Best of luck!
Have a nice day!