Collateral Loans on Property: What They Are and How They Work

If you have ever provided any valuable asset or document to assure someone that you will fulfill an obligation, you definitely have an idea of what collateral loans on property are. These loans allow you to borrow money even with a limited credit history by sharing partial ownership of your property with a lender.

Many people use property as collateral for a mortgage. Others provide a vehicle as a repayment guarantee for an auto loan. But collateral loan options are much broader. Below are some examples, along with an explanation of how collateral loans work.

What Is a Collateral Loan?

A collateral loan is a secured personal loan that requires backing in the form of your valuable property. Although secured personal loans pose a potential danger, they have several benefits over unsecured loan options. First, they are much easier to get with credit issues. Second, they allow borrowers in good standing access lower interest rates. However, there are some risks too. The main danger will occur if you violate the loan repayment terms. This way, you can lose your property through a foreclosure process.

How Do Collateral Loans Work?

A collateral loan works similarly to unsecured loans but with a key distinctive feature: you must provide collateral to get the funds. By doing this, you can access better loan terms or get approved for a loan from a traditional financial institution. Collateral loan rates are usually lower than those on unsecured options. Other benefits may include longer repayment terms, lower down payments, or access to the needed amount with bad credit.

When you apply for a collateral loan, you simply fill out an application form. Then, a lender needs to assess the cost of collateral. This is made to determine whether you can get the requested amount. Please note that the sum you can be approved for with a pledge loan is typically lower than your asset's cost. In most cases, you can get between 50% and 90% of your property’'s market price. The exact number depends on the loan type and the state of your asset.

It’s important to note that you can only use the part of the property that actually belongs to you. Suppose that you still pay the mortgage and are going to pledge the same house. This way, only the equity amount you actually own in it will be used to calculate the sum you can get. This means that a lender will check your loan-to-value ratio along with the asset's cost.

If you get approved for the requested sum, you need to provide a lender with partial ownership of your property and sign a loan agreement. Then you will get a direct deposit into your bank account or get access to a line of credit you can use when needed.

In most cases, a collateral loan repayment mechanism is similar to an unsecured one. You typically make fixed monthly payments within several months or years. However, there are options that work like credit lines or payday loans. Thus, your particular loan terms will depend on the loan type, your credit score, and the lender.

What Does Collateral Mean?

Collateral is any borrower's property that meets the following three conditions:

• It's owned by the borrower;
• It has a value that exceeds your potential loan amount;
• It can be repossessed and sold by a lender in case of loan defaults.

The asset you provide as collateral shows that you're serious in your intention to repay the loan. Thus, it reduces the lender's risk of not getting its money back. It also allows a borrower to access more favorable loan terms or less strict eligibility requirements.

What Is Collateral for a Loan: Examples

Various valuable personal assets a borrower owns can be used as collateral. A valuable asset can be either moveable or immovable. Sometimes, a borrower can use their potential benefits too, for example, when they pledge their investment account. Some common collateral examples for secured loans include the following:

• House
• Car or recreation vehicle
• Savings account balance
• Investment account
• Jewelry and art
• Future paychecks

Types of Collateral Loans

Below are some common types of collateral loans available. We've categorized them based on the type of property you own and are going to use as a pledge.

Loan with a Home as Collateral

Current or potential homeowners can access the following collateral loans.

Mortgage Loans

A mortgage loan is a specific-purpose loan that people get to purchase real estate. A fun fact about a mortgage loan is that it allows a borrower to use the house as collateral even though they don't own it yet. In most cases, a mortgage requires you to make a down payment, which typically starts from 10% or 20%. The more you pay upfront, the lower the interest rate you can expect to get. Additionally, you can use some other assets you own to provide them instead of a down payment.

Home Equity Loans

Also known as a second mortgage, a home equity loan is a debt that you can take out against the equity you own in your house. Equity is the difference between the amount you owe and the total cost of your house. Thus, a home equity loan can be obtained even if you still pay a mortgage on the same home, but the amount will be limited. The approved amount, which is typically a percentage of your equity cost, will be deposited in one lump sum into your bank account. Then, you can use it at your discretion.

Home Equity Lines of Credit (HELOCs)

A home equity line of credit (HELOC) shares some similarities with a home equity loan. It also uses the equity you own in your home as collateral. The difference is that you get access to a revolving line of credit with a draw and repayment period. Within the draw period, which is usually between 5 and 10 years, you can use the money for any needs within your credit limit. The repayment period is for redemption only. The total HELOC repayment period is usually 25 to 30 years. 

Loan with a Car as Collateral

If you own a car or are going to purchase one, below are some options you can turn to.

Auto Loans

An auto loan is a form of debt with a specific purpose, which is buying a new or used auto. Just like with a mortgage, the car you purchase but don't fully own yet will be used as the repayment guarantee.

Cat Title Loans

A car title loan is a short-term bad credit loan that allows you to get the money on hand in exchange for your vehicle's price. The good news is that you're allowed to use your car while it's pledged. In most cases, you can get about 50% of your car's value. Instead of making a fixed monthly payment over some time, you need to repay the whole loan cost within up to 31 days, typically by your next paycheck.

Loan with Other Assets as Collateral

If you don't own a house or car, here are some alternative options that may suit you. 

Business Loans

If you're an entrepreneur, you can get a business loan by using real estate, inventory, or equipment as collateral. Typically, the funds you'll get can be used only for some of your business goals. Although there are unsecured business loan options, they typically come with higher interest rates.

Secured Credit Cards

This option is pretty popular with borrowers who don't have a credit history but want to build it. To get one, you need to provide a lender with a cash deposit upfront. The amount you use as a security deposit typically equals your secured card limit. If you manage to pay on time, a lender can refund your collateral after you pay off your balance and close your account. Additionally, you will be able to apply for a regular credit card.

Share Savings Loans

Share savings loans are loans that people obtain against their savings account balances. The amount you can take can't be more than your balance. If you fail to pay on time, a lender has the right to withdraw the amount you owe from your account.

Portfolio-Based Loans

If you have any securities, such as bonds, stocks, certificates of deposits, or insurance policies, you can also get a secured loan. This loan is usually called a portfolio-based loan or loan against securities. Additionally, you can use securities as collateral for a mortgage, an auto loan, or even a business loan. 

What Is The Process of Providing Collateral?

When you pledge an immovable asset, the process is called mortgaging. When it comes to movable property, lenders typically call the process hypothecation. The whole procedure is usually simple but requires more time to complete compared to an unsecured loan process.

After you complete a loan application process, a lender needs to appraise the property you provide. This underwriting process may take from several days to several weeks. By doing this, the loan provider determines the amount it can give you and assess collateral risks. Then, the lender makes a loan decision and notifies you about the amount you can get. If it suits you, you need to visit the lender's branch and sign a loan agreement.

In addition to a loan contract, you need to sign documents that provide the lender with access or partial ownership of the asset you use as collateral. These documents may include a security agreement, deposit account control agreement, mortgage, and others.

How Much Do Collateral Loans Cost?

The exact cost depends on multiple factors, so there's no single number that lenders apply. On average, borrowers with good credit can get an annual percentage rate from 3% to 6%. If your credit score is bad or poor, an APR can rise up to 36%. Among other features that affect your loan interest rate are the collateral value, type of loan, down payment amount, repayment terms, specific lender conditions, and more.

Pros and Cons of Collateral Loans

To determine whether a collateral loan is the right solution for you, consider its pros and cons.

Pros:

• You can get approved even with bad or poor credit;
• Lower interest rates compared to unsecured loans;
• Higher amounts are available;
• You may not be asked to provide a down payment.

Cons:

• You risk losing your asset if you stop paying; 
• If you apply for a long-term loan, it's hard to predict what your financial situation will be over decades;
• Longer loan process;
• Restrictions on your loan purpose may be applied.

Where to Get a Collateral Loan?

The lender choice typically depends on the type of loan you're going to get. Another factor is the collateral you use. For example, car title loans are offered by alternative lenders, while home equity loans are products you can get from conventional financial institutions. Commonly, you can compare offers from banks, credit unions, online lenders, and auto dealerships or seek help from pawn shops.

Collateral Loans vs. Unsecured Loans

Unsecured personal loans are less risky for a borrower. However, this also leads to stricter eligibility criteria that one must meet to qualify. Having lower credit scores can be an obstacle to getting an unsecured loan.

On the other hand, collateral loans put your property at a risk of being seized. At the same time, they are easier to get with bad credit. Additionally, they have more advantageous loan terms compared to analogous unsecured loans. Those who are looking for lower interest rates or down payments or have credit scores that don't allow them to obtain an unsecured personal loan can take advantage of a collateral loan.

However, it's crucial to fully understand all the related risks and take them responsibly. Only get a collateral loan when you know you can afford loan payments. Access your financial situation not only at the moment but also in the long run.

How to Get a Secured Loan?

Although the process may vary by lender, below are some common steps to take:

1. Review your credit reports. As you don't know what credit bureau a lender uses to check your credit score, it's better to review all three of them. Each credit bureau allows you to request its credit report for free once a year. This will help you understand what interest rate you can expect to get.
2. Choose a lender. Lenders are free to set loan conditions at their discretion as long as they don’t break laws. You need to choose the most beneficial option. To do this, pre-qualify for a loan with several lenders and compare their offers. Then, choose the one with the most favorable terms.
3. Gather documents. In most cases, you will be asked to provide proof of your monthly income, along with tax documents, mortgage statements, and collateral documents.
4. Complete a formal application. You need to fill out a loan application form and attach all the required documents.
5. Access the funds. While some loans can provide you with money within one business day, others may take up to 60 days to be transferred to you or to a seller.