If you’ve been looking into different ways to borrow money, you might have heard the term collateral loan. But what does it actually mean, and how does it work?
In this blog, we’ll explain what collateral is, how these loans work, and when it might be a good option to consider.
What is collateral?
Collateral is something valuable you offer as a form of security for a loan. Most often, it’s your home or another property, which is why they're often called secured loans or homeowner loans. In fact, even a first mortgage is a type of collateral loan, because the lender uses your property as security.
If you can’t repay the loan, the lender may be able to take the property to get their money back. Because there’s less risk for the lender, they may be more willing to offer you the loan or give you better rates. So, it can be a more flexible option for some borrowers.
Why might someone get a collateral loan?
There are a few reasons why a collateral loan might be a good fit:
- You’ve been turned down for an unsecured loan: This could be due to your credit score, income, or loan purpose.
- You want a lower interest rate: Because there’s less risk for the lender, rates can often be better than on unsecured loans.
- You need to borrow more money: These loans often allow for bigger loan amounts.
- Your income changes month to month: If you’re self-employed or have multiple income sources, lenders may be more flexible if you offer collateral.
In general, it can be useful if you’re struggling to get approved elsewhere, or you’re looking for more flexible options.
What can be used as collateral?
Most people use their home, either the one they live in or a rental property, as collateral. But in some cases, other assets might be accepted, such as:
- Savings
- Stocks or investments
- Valuable vehicles
- Business assets (for business loans)
That said, not every lender will accept all of these. In the majority of cases, property is the most common type of collateral.
How does a collateral loan work?
Here’s how the process usually goes:
- Apply: You send in a loan application and let the lender know which property you’re offering as security.
- Valuation: The lender checks how much your asset is worth through a physical or a desktop valuation.
- Offer: If all looks good, you’ll get a loan offer with the amount, interest rate, and repayment terms.
- Securing the loan: The lender puts a legal charge on your property, similar to a mortgage.
- Monthly payments: You pay the loan back over time, with interest.
- Loan repaid: Once you’ve paid it off, the legal charge is removed.
Is a collateral loan right for me?
While this can be an effective form of borrowing for many people, this type of loan isn’t for everyone. It might work well if:
- You’ve tried other options, like unsecured loans, without success.
- You’re confident you can keep up with the repayments.
- You need to borrow more or want better rates than an unsecured loan.
Just remember, because the loan is secured against your home (or other asset), you could lose it if you can’t keep up with repayments. So it’s important to fully understand what you’re agreeing to before moving forward.
Summary
Collateral loans can be a helpful solution when other borrowing options aren’t suitable, or when you need a larger loan. But they do come with risks, so it’s always worth getting advice before you apply.
Loans are secured against property. Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a mortgage or any other debt secured on it.
