When you apply for a personal loan, your lender may ask for collateral. Collateral for a personal loan is any asset or belonging that you use to back up a loan. Many times, collateral can be your car, house, or investment account.
For a lender to be satisfied to extend you a collateralized, or secured, loan, your asset must be of equal value or its value must exceed the amount of the loan.
Some lenders may not accept collateral for their loan, while others may only allow one type of collateral such as a car. Depending on your financial situation, it may be a more fiscally responsible decision to opt for a collateralized loan.
However, to make this decision, you’ll have to understand what types of loans require collateral, which is best for your financial situation, and what can be used as collateral to know if this type of loan is a good idea for you.
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Secured vs. Unsecured Loans
Most types of loans you apply for will either be secured or unsecured loans. A secured loan requires some form of collateral, while an unsecured loan does not.
With a collateral loan, the loan is secure for the lender because if you fail to pay back your loan, you will forfeit the collateral and it will be used to pay back the lender.
Because of the collateral, a lender may attach a reduced interest rate to your loan and may increase the loan amount and term. Examples of secured loans include:
- Car title loans;
- Mortgage loans;
- Home equity and home equity line of credit (HELOC) loans;
- Secured credit cards;
- Pawnshop loans;
- Bad-credit loans.
Unlike a secured loan, the availability of an unsecured loan will depend on your creditworthiness. Unsecured loans are often called a “signature loan” or “good faith loan.” For this loan, the lender will examine your financial and credit history to determine approval.
Unsecured loans typically come with a higher interest rate (especially if you have bad credit), and generally are of lower value, with a fixed term. Unsecured loans can see money in your bank account faster, and you are even able to get an unsecured loan with bad credit. Examples of unsecured loans include:
- Student loans;
- Same-day loans;
- Installment loans;
- Direct deposit loans;
- Most emergency loans.
Before you choose any of these loans, it will be vital that you understand if the lender requires collateral. Often, your financial situation will determine your decision as to which type of loan to get — mainly, it will determine how you will handle these loans with bad credit.
Which Is Best for Bad Credit?
You can find both secured and unsecured loans fairly easily with bad credit. Which is best for those with bad credit will come down to your personal financial situation. For instance, if you have the collateral for a secured loan and are confident you can pay it off to receive your collateral back, you may forgo an unsecured loan with its higher APR and lower loan amount.
Many times unsecured loans offered to those with bad credit have unreasonably high interest rates attached. This can cause you to default on your loan — trapping you in a nasty cycle of debt. On the other hand, if you cannot pay back your secured loan, your asset(s) you offered for collateral will become the lender’s.
Additionally, you may need money quickly. For these instances, it may be better to apply for an unsecured loan such as an emergency or same-day loan — as they tend to be approved quickly and often will be transferred to you within 24 hours.
However, these loans may not be the right type of loan for you. For a higher-value loan with a lower interest rate and loan term, look for a secured loan available for people with bad credit.
Lastly, if you are finding it difficult to get an unsecured loan because of bad or no credit, you may find it a bit easier to get a secured one. If you have the collateral for a loan, a lender may be more willing to extend you a loan because they’ll already have the assurance that the loan will be paid off one way or another.
What Can Be Used as Collateral for a Personal Loan?
Before you apply for a secured loan, it is important that you know what can be used for collateral. If a lender accepts only vehicles for collateral and you can’t afford to have your car taken, you should not accept the loan.
Generally, banks and credit unions, as well as online and in-person lenders will allow the following assets as collateral for a secured loan:
- Cars, boats, RVs, and trailers;
- Collectables such as coins;
- Investments and savings accounts;
- Real estate.
Ask your lender if they will accept any other form of collateral if you cannot part with or don’t have the items above.
How Much Collateral Do You Need for a Loan?
As a general rule, the collateral you offer must be of equal value or greater than your loan amount. Especially for small business loans, lenders may follow a loan-to-value ratio.
A large number of lenders will not give you a loan for the same amount of your collateral, and will use this loan-to-value ratio with your credit score and other financial history details in mind.
They may offer only 80% of your collateral’s value when extending you a loan. In this instance, they would offer you a $16,000 loan if your car’s value is estimated at $20,000. Loan-to-value ratios will be set by your lender, but can range from 50% to 98%.
Are Collateral Loans a Good Idea?
In an ideal situation, secured loans backed by collateral can be a good choice. They are more likely to be approved (even with bad credit), you may receive a larger loan amount, and if your money is tied up in other things you can offer up an asset to get some cash.
On the other hand, if you find that you can’t pay the loan back, you’ll give up the asset(s) you used for collateral. If you used your car or home for collateral, this can be devastating to you and your family if the asset is seized by the lender. While you may not give up your car or home, you still may lose things that hold sentimental value to you if you cannot pay the loan back.
Where Can You Get a Collateral Loan?
You can find secured loans from a variety of lenders. Many financial institutions will extend collateral loans as well. If you find that a collateral loan might benefit you, check with national and local banks and credit unions, and both online and in-person lenders.
Understand that each lender will have their own loan terms, interest rates, and loan amounts. You will need to shop around to find one that works for your financial situation.
The risk of losing your assets can be enough to make some people shy away from a secured loan. However, collateral loans can be great for those with bad credit, and for those who know they will be able to pay off the loan.
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