It can be tough to secure financing for your small business, home renovation or even debt consolidation if your credit isn’t stellar. But if you need financing fast, there’s another option: collateral. With collateral, you might qualify for a loan where you wouldn’t otherwise.
Not sure if you have collateral to use for a loan? Odds are you do. There’s collateral for practically every loan you can imagine, so let’s break down the types of collateral in detail.
Short answer: collateral is like a security deposit for a loan. Long answer: if you take out a loan with collateral, then fail to pay back the loan on time, the bank or other lender can seize the collateral.
In a way, collateral can be thought of as insurance for the lender – it guarantees they get something if a borrower defaults on the loan agreement. In exchange, they might be willing to offer loans to folks without the best credit. If you need a loan fast, collateral can make a good loan more accessible.
One easy example is a mortgage loan. Mortgage loans by default have collateral attached: the property the mortgage finances. If a homeowner doesn’t pay their mortgage bill, the lender can take ownership of the house and use it to recover some or all their costs.
Collateral is the primary difference between a secured and unsecured loan. A secured loan simply includes collateral for the lender’s sake. An unsecured loan means there isn’t any collateral included with the loan contract.
Because collateral makes a loan safer for lenders, many “bad credit” loans are secured. They have some kind of collateral included in their contracts to make up for the borrower’s low credit score.
Just like there are different types of loans, there are also many different types of collateral you can use to secure a loan to pay off bills, buy a car, make home improvements, etc. Often, the type of collateral used is related to the type of loan you want to get.
Additionally, most lenders require the collateral to be valuable and/or sellable to a buyer to recover their losses in a reasonable timeframe. These factors make certain types of property, like houses or cars, better options for collateral than other things.
Still, so many things can be used as collateral, you probably have several options you haven’t realized. Let’s explore collateral types more closely.
Real estate is often used as collateral, as in the above example of a mortgage loan. However, real estate can also be used for other loans, like business loans and home equity lines of credit.
With a home equity line of credit (HELOC), a borrower takes out a revolving line of credit for a certain timeframe up to a maximum amount. In exchange, the HELOC includes the borrower’s equity in their home as collateral.
Real estate is usually a very reliable form of collateral. Lenders almost always agree that it’s valuable. If you own your own home, your house’s equity is a great place to start looking for collateral for a loan.
Business owners looking to take out a business line of credit or loan might use their own equipment or inventory as collateral. In many cases, business equipment or inventory is a safe option as collateral – this way, your home or other personal property isn’t on the line if you default.
However, business equipment or inventory can depreciate or lose its value with time. That means business equipment is only suitable for certain loan types and only if it’s in good condition. Furthermore, many lenders won’t accept business equipment or inventory as collateral if they don’t think they’ll be able to find a buyer.
Still, it might pay to take stock of your business’s inventory and see what’s worth putting up as collateral.
Some auto loans use the vehicle they cover as collateral, especially if the vehicle is new or expensive. You can put up your car as collateral for a personal loan as well, though the value of the collateral is dependent on the value of the vehicle and how much it may have depreciated over time.
Naturally, cash can work as collateral since any lender can use it to immediately recoup their costs from a loan that defaults. However, this type of collateral is usually only available if a borrower takes out a loan from a bank where they have an active account. In these cases, the bank can simply liquidate the borrower’s account if they default on their loan.
Collateralized personal loans are special loan types that require a borrower to offer an item of value as collateral. A basic example is a pawnshop loan; borrowers can give a valuable item like a watch to the pawnshop in exchange for cash, then repay the loan in exchange for that item later.
You might have some suitable items around your home right now. Look around. In a pinch, a piece of jewelry, a firearm, or other valuables can help you get cash fast.
As you can see, collateral can be a flexible way to secure financing for personal reasons or for your small business. However, you need to choose your type of collateral carefully, plus decide whether signing onto a secured loan is worth the risk.
Sources accessed 8/8/2021 –
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