• Preston Morris

What is a collateral loan?

A collateral loan is often called a secured loan. This means the loan is guaranteed by something you own, and if you can't pay your loan back, the lender has the right to claim the collateral, whether it's a car, savings account, piece of jewelry, investment portfolio or a home. A collateral loan can offer a lower interest rate or larger loan amount than with an unsecured loan like a credit card. In some cases, it may be the only loan option for a borrower who has either a short or unsteady credit history, or whose income is too low to qualify for an unsecured loan.


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How Collateral Works

Before a lender issues you a loan, it wants to know that you have the ability to repay it. That's why many of them require some form of security. This security is called collateral which minimizes the risk for lenders. It helps to ensure that the borrower keeps up with their financial obligation. In the event that the borrower does default, the lender can seize the collateral and sell it, applying the money it gets to the unpaid portion of the loan. The lender can choose to pursue legal action against the borrower to recoup any balance remaining.


As mentioned above, collateral can take many forms. It normally relates to the nature of the loan, so a mortgage is collateralized by the home, while the collateral for a car loan is the vehicle in question. Other nonspecific, personal loans can be collateralized by other assets. For instance, a secured credit card may be secured by a cash deposit for the same amount of the credit limit—$500 for a $500 credit limit.


Loans secured by collateral are typically available at substantially lower interest rates than unsecured loans. A lender's claim to a borrower's collateral is called a lien—a legal right or claim against an asset to satisfy a debt. The borrower has a compelling reason to repay the loan on time because if they default, they stand to lose their home or other assets pledged as collateral.


How to Apply for a Collateral Loan


If you think a collateral loan is the right option for you, be sure you get approved by following these important steps:


  1. Check your credit. Securing a loan with collateral can help you get approved for a loan even when your credit isn't excellent. However, it's still worthwhile to make sure your credit is as good as it can be to get the lowest collateral loan rate and best repayment terms. You can pull your credit reports for free at annualcreditreport.com; check them for errors or any negative marks that you need to fix before applying for a loan, such as a past due payment.

  2. Choose your collateral. If you are applying for a home or auto loan, the collateral backing your loan will be the property you're financing. However, if you are taking out a secured personal loan, you have options. Determine which assets you have available to secure your loan and try to choose those that are liquid and easily accessible, such as funds in a bank account.

  3. Gather your documentation. Once you're ready to apply, it's helpful to gather up all the documents and information you'll need ahead of time. Some information you can expect to be asked for includes: personal details, including your name, birthdate, Social Security number and driver's license or other government-issued identification; proof of income and assets, such as W-2 forms, pay stubs, recent tax returns and bank statements; list of liabilities, such as existing debt payments, monthly rent or mortgage payment, child support or alimony payments and other monthly obligations.

  4. Shop around for the best collateral loan rates. Before you go through the full application process, it's important to get quotes from several lenders and compare the collateral loan rates and terms. You can easily get quotes online, which typically only require a soft credit check and won't impact your credit.

  5. Choose your lender and apply. Once you find an offer that fits your budget and needs, you can go through with the full application process. Note that officially applying for a loan will result in a hard credit check, which is noted on your credit reports. However, it should have a temporary and minimal impact on your credit score.

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Secured Loan vs Unsecured Loan

When a loan has a type of security attached to it (like the title of your car or a high credit score) then it is also known as a secured loan.


When a loan doesn't have any type of security attached to it, then it's known as an unsecured loan. The risks the lender takes on when issuing an unsecured loan are higher because the chances the borrower will fail to repay the loan are higher.

Pros and Cons of Secured Loans vs Unsecured Loans:

  • Unsecured loans usually have much higher interest rates and fees

  • Secured loans include using your own property or assets to secure the loan

Types of Secured Loans:

  • Personal loans

  • Title loans

  • Mortgage

  • Pawn loans

Types of Unsecured Loans:

  • Signature loans

  • Student loans

  • Credit cards

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