Collateral & Collateral Based Lending
Collateral & Collateral Based Lending
Collateral based lending is when you’re able to obtain a loan using a form of collateral you put up as insurance. Let’s look at what defines collateral, what the benefits are to using collateral lending and some of the different types of loans you may be able to choose from if you’re planning to use collateral to secure lending.
What is Collateral?
Collateral is just what they refer to for an asset you offer a lender as a guarantee that you’ll repay the loan. In essence, the collateral you put up is protection for the lender because if you end up defaulting on your loan (not paying it back) the lender could take your collateral in lieu of payment.
Collateral could be anything from a bank account to physical property. Assets that are deemed “good“ collateral would be very liquid (meaning they could be easily exchanged for cash or they hold extreme value) and finally, their value would remain stable.
Any asset used for a collateralized loan must be transferable, so if the lender were to seize it, it would actually be worth something to them.
Benefits of Collateral Based Loans
There are several benefits to using collateralized lending. Perhaps the biggest reason to consider this type of loan stems from the borrowing power it can offer. Even if you don’t have perfect credit (or maybe especially if you don’t have it), collateral secured loans can be an option you may want to consider.
Because you’re offering up a guarantee in return for the sum of money you’re borrowing, it tends to be easier to get approval for a collateral secured loan. Even if you’ve been turned down by other lenders, you can substantially reduce the risk a lender may see you as by having collateral.
Traditional loans depend on your good credit. The length of time you’ve had credit and how well you’ve made payments may affect your power as a borrower. Collateral might be able to offset some of your negative credit history, if you have any.
Collateral lending often has less restrictive terms. You may be able to borrow more and get a lower interest rate. Some loans even offer longer terms. Several things will come into play here, including the value of your collateral, but you could end up with a more beneficial and lenient loan when you put up a physical guarantee.
Having less restrictions on your loan means you may have more freedom to make your money work for you however you see fit. Lenders who have your collateral as security are generally not as concerned about how or what you use a loan for.
Lower Interest Rates
A huge benefit to a collateralized loan is the lower interest-rate it may have. Because the loan carries less risk for the lender, they’re often much more flexible with the APR they charge. A lower APR could mean substantial savings over the life of your loan - sometimes to the tune of thousands of dollars saved.
When you can save even just a small percentage on your interest rate, your money goes much further. Note that a lower APR may not be feasible if you’re obtaining an auto or mortgage loan.
Types of Collateral Based Loans
Collateral based lending is often used for both personal as well as business loans. It’s a fairly common loan type for newer businesses, who don’t yet have a long credit history or who aren’t quite showing a profit yet. But they’re just about as common for personal loans, too. The type of collateral put up largely depends on what size loan you’re looking for.
Personal loans can be used for virtually anything. People will borrow money to pay for medical bills, or consolidate debt or even fix up their home. Somewhat ironically, personal loans can actually be used to build up your credit. By establishing a good credit history and making timely repayments, you could actually pay back the loan and be in much better credit standing than you currently are.
Generally, a house, savings account, vehicle or even future earnings and income might be used as collateral for a personal loan.
Small Business Loans
Especially when small businesses are first starting out, the need for capital can be incredibly daunting. Small business loans can be used to grow a business, purchase equipment, obtain office space or even allow for the hiring and training of staff.
It’s not uncommon for small business owners to put up personal assets as collateral. This could be in the form of their own home, or in the money they have in personal accounts. In some cases, lenders will require a personal guarantee by way of a signed statement that acknowledges the borrower's collateral can be seized if they ever default on the loan.
Mortgage & Auto Loans
Finally, secured loans for mortgage and auto purchases are the most common. In these cases, the actual asset you’re borrowing for can be used as collateral. If you get a collateral-based auto loan and don't repay it, the car can be seized. Likewise, the property can be taken if you fail to repay the mortgage loan per the terms you agreed to.
Both of these loans generally require an appraisal to ensure the collateral you’re putting up is valued high enough that it would cover the loan.
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