Whenever you apply for credit, lenders will want a guarantee that you’ll be able to pay it back. Of course, most lenders will look at your credit score and income for this. However, depending on the loan, some lenders may require you to pledge collateral.
To put this into perspective, when you take out a mortgage, you pledge the home as collateral. This collateral essentially protects the lender from losses. Particularly, in the event that you default on your loan.
And while most personal loans don’t usually require collateral, some do. However, unlike mortgages, there’s really no limit to where you can use a personal loan. To that end, what can you use as collateral? In this article, we’ll be answering just that.
What Is Collateral?
In brief, collateral is an asset that you pledge to guarantee a loan. As mentioned, this collateral serves to protect the lender from losses if you’re unable to repay. And because lenders are taking on less risk, collateral makes it more comfortable for lenders to extend credit.
To explain, let’s assume you take out a personal loan and pledge your car as collateral. You can use your car even if you use it to guarantee a loan. But, if you suddenly become unable to repay the loan in full, the lender can seize your car. With that said, you risk losing whatever you use as collateral.
However, because your asset is guaranteeing the loan, lenders typically offer better terms. This includes lower annual percentage rates (APRs) and longer payoff periods. For instance, you can get a secured loan with an APR of under 6%. On the other hand, you’ll typically receive an unsecured loan for a 9.35% APR.
Secured vs Unsecured Personal Loans
Personal loans, while generally unsecured, come with a secured variant. In other words, a loan that requires you to use collateral. In contrast, an unsecured personal loan doesn’t require you to pledge anything.
To that end, if you’re unable to repay the loan, your lender can’t claim collateral as compensation. As a result, Unsecured loans usually have higher interest rates than secured loans. Because lenders are taking on more risk when extending unsecured loans.
Granted, you can guarantee an unsecured loan without using collateral. Lenders who issue unsecured loans seek reassurance by looking at your creditworthiness. And they do this by looking at your credit history, as well as your income and other factors.
Advantages Of Using Collateral On A Loan
As mentioned, you can take out a personal loan without using collateral. However, there are certain advantages you get by doing so. This includes:
- Better chances of qualifying. Lenders want to make sure that you can repay a loan before extending you any credit. However, if you have a damaged or limited credit history, that may be difficult. But, if you use collateral, lenders become more comfortable lending to you. Because they have something to use to cover any losses.
- More borrowing power. The higher the loan amount, the greater the financial risk for a lender. With collateral, however, you reduce that risk. As a result, you may be able to borrow more money. Specifically, more than what you’ll be able to with an unsecured loan.
- Better loan terms. Because lenders are taking on less risk with secured loans, they can offer much better terms on your loan. This typically translates to lower interest rates and longer repayment periods than unsecured loans.
- Chance to build credit. In order to build credit, you’ll need to use credit. However, lenders are less willing to extend you any if you have a damaged or limited borrowing history. But, as mentioned, you’ll typically have better chances of qualifying for secured loans than unsecured ones. This can help you start to establish a strong and positive credit history.
Types Of Collateral You Can Use
In the case of a mortgage or auto loan, your house or car is usually the collateral. However, on personal loans, there are several types of collateral that you can pledge. This may include:
- Cash in savings accounts.
- Cash in certificate of deposit (CD) accounts.
- Insurance policies.
- Fine art.
- Future paychecks.
- Investment accounts.
- Retirement accounts.
Do understand, however, depending on the lender, certain assets can’t be used as collateral. For instance, some lenders don’t qualify 401(k) or IRA accounts as collateral. Furthermore, some lenders may not accept vehicles over five to seven years old as collateral.
The Bottom Line
In summary, a secured loan is a loan that requires you to pledge collateral. In other words, an asset that the lender can use to guarantee the loan. And to cover their losses in the event you’re unable to repay.
Fortunately, there are a number of different assets you can use to secure a personal loan. In contrast, you can only use your home or car on a mortgage or auto loan. However, you do risk losing your asset if you suddenly become unable to pay back your lender.
If you don’t want to risk any asset you may have, then you need to fix your credit. Your credit score represents your creditworthiness or your likelihood to repay a debt. The higher your score, the better your chances of qualifying. And the better terms you may get on your loan. Call us at 888-799-7267 to schedule a Free Credit Consultation.
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