Whether you're just starting to build credit or perhaps your credit is really a work in progress, it may be easier to qualify for a loan if you are willing to put up some kind of collateral. This may be your home, car or even the first edition copy of “Alice's Adventures in Wonderland” you retain in your safe.
Loans secured with collateral may also help you be eligible for a a lesser rate of interest and better terms. Then again, it might mean risking your collateral if you can't repay your financial troubles. Think about these pros and cons of collateral loans before you apply.
What Is a Collateral Loan?
Loans can be unsecured or secured. A collateral loan, or secured loan, is guaranteed by an asset you have. If you stop repaying your loan, the lending company has got the right to claim the collateral.
There are many common kinds of secured loans:
- Mortgages: Whenever you remove a mortgage, your house can serve as collateral for the home loan. Should you miss enough payments and default on your loan, the lending company may take possession of your home inside a process called foreclosure to extract their losses.
- Auto loans: If you get a loan to purchase a car, truck, motorcycle or another vehicle, the vehicle it is used to purchase typically secures the borrowed funds. If you fail to repay the auto loan, the vehicle could be repossessed.
- Secured unsecured loans: A secured personal bank loan guaranteed with collateral may be easier to be eligible for a and you may be eligible for better rates and terms in your loan. However, you risk losing the asset you used to secure the personal loan should you default.
Although each of these loans can be an effective way to borrow money and fill a need, you will find both benefits and risks to be aware of.
Pros of Collateral Loans
Most banks, credit unions along with other banking institutions offer collateral loans. Although rates and terms vary from one lender to another, the professionals offer a similar experience no matter where you receive the loan.
Good if Your Credit Needs Work
If you are establishing credit for the first time, possess a short credit history or perhaps your credit needs work, a collateral loan might be a good option to get the funds you need. Lenders look at your credit rating, credit history, income and other factors when looking for your creditworthiness and chance of defaulting on your loan. So, even when your credit needs work, you might still be able to be eligible for a financing if you're willing to set up collateral. That's because collateral reduces the risk towards the lender, which may make them more likely to approve the application. If you miss payments or can't repay your loan, they are able to make use of your collateral to extract their loss.
Potential for Better Rates and Terms
Because you are reducing the lender's risk by securing your loan with collateral, it's possible you may be eligible for better rates of interest and terms in your loan. Having a large loan, even a slight reduction to your rate of interest could save you significantly within the life of the loan.
Possibility of Larger Amounts
Although available loan rates, terms and loans change from one lender to the next, it's possible you may be eligible for a a larger loan amount with sufficient collateral. Along with determining the rate you receive based on the asset you are offering as collateral, the lender could also determine the borrowed funds amount based on your asset's value.
Cons of Collateral Loans
Aside from the benefits collateral loans can provide, there's also drawbacks.
Risk of Losing Your Collateral
The single greatest disadvantage to collateral loans is the risk of losing your collateral if you cannot repay your loan. If you have a mortgage or auto loan you cannot repay, losing those assets towards the lender might cause you serious hardship.
Longer Qualification Time
Since it can sometimes be hard to place a value in your collateral, the approval process for a secured loan might take longer than with an unsecured loan. For instance, let's say you have a valuable art collection you are using as collateral for the loan. Finding a qualified professional to evaluate the worth of your collection can take some time and may delay you receiving the proceeds from the loan.
Potential to Harm your Credit
Defaulting on the secured loan has got the same credit consequences as defaulting on any other type of credit. If you default in your loan and your lender repossesses your collateral assets, that blemish usually stays in your credit history for approximately seven years.
Considering the most important factor when calculating your credit score is payment history—accounting for 35% of your FICO® Score☉ —the outcome of failing to repay your loan could be significant.
Is a Collateral Loan a Good Idea?
Collateral loans can be beneficial under certain circumstances. For example, for those who have less-than-perfect credit and should not be eligible for a financing any other way, a secured loan may be a good choice. At the same time, it's important to take into account that a collateral loan presents a considerable risk if you need to forfeit your collateral because you cannot make payments.
If you possess the income along with a plan for repaying the loan, which may take in any unforeseen circumstances, then a collateral loan is most likely a safe bet. But when you're already low on cash, you do not feel at ease putting up your house as collateral or you don't have collateral that qualifies for a secured loan, you might want to consider an alternative funding option.
Alternatives to Collateral Loans
If you have researched your options for collateral loans and decided they might 't be for you personally at the moment, it's good to know you will find alternatives.
Unsecured Personal Loan
Unsecured personal loans that you could typically get through banks, lending institutions, online lenders and peer-to-peer lending platforms don't require any kind of collateral. Rather than counting on a good thing as to safeguard the loan, lenders approve unsecured loans according to your overall creditworthiness. You will not risk losing your collateral if you default on your loan, but you will probably need good to excellent credit to get approved. Plus, it isn't uncommon that you might still pay a greater rate of interest than a secured loan despite good credit.
Unsecured Credit Card
Charge cards could be secured for borrowers whose credit needs work, or unsecured. Used wisely, they may be another option to a collateral loan, but they may carry higher APRs. Some credit cards provide an intro 0% APR, which could help you save on interest. Throughout the temporary promotional period, you have to pay no interest on purchases; after the intro period ends, you'll pay interest on any remaining balance. Many charge cards also let you earn rewards, but might also charge annual fees and carry high rates of interest.
Cosigned Loan
Adding a cosigner to your loan may help you to qualify even if your credit is less than perfect, and can also help you to get a better interest rate and terms. A cosigner could be a family member or trusted friend who takes responsibility for repaying any missed payments or even the full quantity of the borrowed funds if you're unable. Using a creditworthy cosigner gives your lender the boldness the loan is going to be repaid, although not all lenders allow cosigners. Adding a cosigner and making on-time payments every month on your loan might help boost your credit and make you a better candidate for credit with out them later on.
Credit Union Loan
Lending institutions may be more flexible when providing loans than some traditional banks. This can be because they are not-for-profit organizations of their members, and may offer quick approvals and competitive rates which are often less than some bank rates. Some lending institutions could also offer payday alternative (PAL) loans, which are an inexpensive option to expensive payday loans. However, to get any type of loan via a bank, you have to first registered as a member.
The Bottom Line
Sometimes, it can be easier to obtain a loan if you're prepared to put up some type of collateral, much like your vehicle, home or other valuables you own. Collateral loans use valuable property to secure the cash you're borrowing, and generally provide lower interest rates. They may be a great choice for somebody trying to enhance their credit.
As with other loans, a collateral loan requires coming prepared to pay the money back, even though you receive an unexpected financial emergency. With a secured loan, failing to repay your debt often means losing your asset. With this in mind, prior to applying for a collateral loan (or any other type of credit), review your credit report and scores to determine where you stand.