A collateral loan is a loan secured by some asset you own. You promise to hand the asset over to the lender if you cannot repay the loan as agreed. By using a collateral loan, the lender takes less risk, and it may be easier for you to get funding. Make sure you know the essentials of collateral loans before you use one.
Overview of Collateral Loans
Collateral loans are used when the lender wants some assurance that they won’t lose all their money. If you pledge an asset as collateral, they can take the asset, sell it, and get their money back. Contrast this with an unsecured loan, where all they can do is ding your credit or bring legal action against you.
Assets for Collateral Loans
When using a collateral loan, you give the bank the right to take your asset if you can’t repay. What assets can you use?
- Real estate
- Cash accounts
- Insurance policies
- Valuables and collectibles
- Future payments
Collateral Loan Valuation
In general, the lender will offer you less than the value of your pledged asset. Some assets might be heavily discounted. For example, a lender might only recognize 50% of your investment portfolio for a collateral loan. That way, they improve their chances of getting all their money back in case the investments lose value.
If the assets lose value for any reason, you might have to pledge more assets to keep your collateral loan. Likewise, you may be responsible for the full amount of your collateral loan, even if the bank takes your assets and sells them for less than the amount you owe.
Types of Collateral Loans
You may find collateral loans in a variety of places. In some cases, you get a collateral loan as you buy the asset used for collateral. For example, in premium financed life insurance cases, the lender and insurer often work together to provide the policy and collateral loan at the same time.
There are also some collateral loans for people with bad credit. These loans are often expensive and should only be used as a last resort. They go by a variety of names, such as: