Everyone knows what a loan is, at least we’ve had to borrow some funds from one source or the other at one time or the other. What many may however not know is that there are various types of loans, each having their benefits and disadvantages.
Our focus in this article is a type of loan known as collateral or collateralized loans. Another name for it is secured loan. This type of credit facility requires that the borrower puts up something of value as security for the loan being applied for. It is this asset or item of value that is referred to collateral because it serves to guarantee that the lender will repay the loan taken. If for any reason the borrower does not or cannot repay, this asset will be taken over by the financial institution, liquidated and the proceeds used to pay off the debt.
What Can be Used for Collateral?
Practically any item of value can be used as collateral. Some items commonly used as collateral include the following:
Real Estate: This includes all kinds of property – buildings (residential and commercial), lands etc.
Mechanical Assets: Under this group we have all kinds of vehicles – cars, motorboats, motorcycles, tractors and other such assets.
Jewelry: Precious stones and metals are items of great value that lenders gladly accept as collateral. Items like gold, platinum, diamond etc. have great value that does not depreciate, making them perfect for use as collateral.
Stocks and Bonds: While these financial instruments can easily lose value without warning, they can be used as collateral. In most cases though, its value will be greatly discounted to make room for any possible devaluation.
Savings Accounts: This may come as a surprise to you as you may wonder why you will want to take a loan if you have substantial savings. That discussion will not be covered in this article. You can however learn more about this subject in this article. If you have substantial savings in an account, you can use it as collateral for loan.
Major Differences between a Secured Loan and an Unsecured Loan
Unlike a collateral loan, which we’ve also referred to as a secured loan above, an unsecured loan is a person credit facility that is often given on the strength of the applicant’s credit worthiness. This creditworthiness is measured using the credit score that’s determined by the applicant’s credit history.
The applicant’s creditworthiness will determine if the applicant will have any amount approved for them. It will also determine how much will be approved. The amount that can be offered for this type of transaction will gradually increase as the applicant takes and repays each one.
Given that no security is required for an unsecured loan, the interest charged for it is usually much higher. This is because the risk of non-payment is much higher than with a collateralized one.
On the flip side, a secured loan is given with the backing of an asset of commensurate or even greater value. This way, the lender is completely confident that they will never lose their funds to non-repayment.
As a result of this assurance of repayment or recovery of funds in the case of a default, this type of credit facility can usually be gotten at a far lower interest rate than what may be available with unsecured loans. In the same vein, you can easily have access to much higher loanable amounts. Of course, this will be determined by the value of the asset you present as collateral.
Benefits of Collateralized Loans
From everything we’ve discussed so far, you must have deduced a few benefits that one can enjoy with this kind of loan. However, we will dedicate this section to looking at these benefits in greater detail so that you can have a better understanding of why you may want to consider this option for your loan needs.
Lower Interest Rates
This is easily one of the most obvious benefits that this type of loan offers. Like we explained above, the assurance that the loan will be repaid makes it possible for the lender to offer very low rates. Since this assurance is not just based on the ability of the applicant to pay but on the asset of value that has temporarily been transferred to the lender, there really is no risk for the lender. All the risk is now transferred to the borrower, affording the lender the luxury of charging very low rates.
High Rate of Approval
The only reason why a lender will not approve an application is if there is some doubt as to the borrower’s ability to repay the amount borrowed. Once every shred of doubt in this regard is dissolved, the lender will gladly approve the loan.
What can dissolve any doubt of a possible default more than an asset of equal or superior value whose ownership is temporarily transferred? When an application is backed by collateral that equals or exceeds the value of the amount sought, then there is no reason why such a loan will not be approved by the lender.
Higher Loan Amounts
Unlike with unsecured loans where the loanable amount is determined by credit score and income, among other things, your loanable amount here can be as high as the value of the asset you are willing to put up. This allows you access much higher amounts.
Better Loan Terms and Conditions
Just as with the issue of the interest rate that we looked at above, you can negotiate better terms and conditions if your loan is secured. Again, since the lender has little to no risk to consider, there’s hardly any terms and conditions that will leave them disadvantaged.
Downsides of Collateral Loans
Just as there are benefits to getting this kind of loan, there are also a few down sides and we’ll be going over some of these down sides in this section.
Risk of Asset Loss
The most obvious possible downside here is the loss of the asset that was put up as collateral. No one borrows money without thinking that they can make the repayments. However, despite the best of intentions, we constantly see folks losing their homes or other precious assets because they were unable to make their repayments. This is a risk that must be considered before taking this type of credit facility.
Possible Reduction in Credit Score
Aside from the possible loss of the collateral, there’s also the drop in credit score that could occur if repayments are not made as at when due. While you may consider this a lesser evil, it will impact on your ability to get borrow funds on favorable terms, especially without sufficient collateral.
More Financial Burden from Access to Higher Loan Amounts
This is one of those situations that have two sides. Having an asset of value that you can put up as security for a credit facility allows you access much higher amounts. However, this also comes with the burden of having a higher repayment amount. Having a substantial repayment amount can increase your financial burden, and by implication, increase the chances of you losing your collateral due to non-repayment.
Before Applying for a Collateralized Loan
There are a number of lenders that will be excited to offer you a credit facility once you have suitable collateral. Remember that the absence of risk for the lender makes it almost impossible for the lender to lose. It’s therefore important that you do all you can to ensure that the loan indeed serves your interest.
There are a few things to consider before taking this step. We will look at the most important of these as we conclude this article.
Determine How Much You Need
It’s always a mistake to borrow funds just because you can. Take some time to ensure that you do indeed need the loan and be sure of the amount you need. This is important as it will help ensure you do not take on more than you can repay with ease. You do not want to put yourself under too much financial strain.
Consider the Suitability of the Asset
You should not use just any asset as collateral for any loan. Not everything of value will be considered equally. Lenders will always prefer assets that can be liquidated quickly to those that will take some time to liquidate. The faster an asset can be liquidated, the better it will serve as collateral.
Ensure You can Repay
You clearly do not want to lose your valuable asset so this goes without saying. Be sure that you have your repayment plans clearly laid out before taking out this loan. You can go to billigeforbrukslån.no/lån-med-sikkerhet to get more information that can help you with this.
Now that you’ve gotten the very basics on collateralized loans, you should now be able to make the correct decisions regarding whether or not to proceed with the application and how to go about it. This will ensure that the decision you end up making will be in your best interest.