Whether or not you have a lot of savings, there will be times when you may need to take out a bank loan for whatever purpose. Perhaps you need some money for additional capital for your small business, or maybe a loved one was rushed to the hospital and you need to cover the medical costs.
No matter your reasons for borrowing money, it’s good to know the options you have. When it comes to bank loans, you usually have two options: a secured loan, also called a collateral loan, and an unsecured loan, or non-collateral loan.
A collateral loan is a type of loan in which you pledge an asset or collateral with the lender (in this case, the bank) in exchange for the loan proceeds. The lender will then “keep” this collateral until your debt is paid. This is why it’s called a secured loan. By pledging an asset, you’re basically reassuring the lender that you’re going to pay off the amount you borrowed—or else, you’ll lose what you pledged.
In contrast, an unsecured or non-collateral loan does not require you to pledge an asset. Instead, it’s supported by factors like your credit score and your financial capacity at the time you took out the loan. This means that the bank doesn’t have any security. In case the situation changes and you are suddenly unable to pay off the loan, the bank will lose the money.
In some situations, going for a collateral loan may be a better option. Below, we discuss some of the most crucial details so you know what to factor in before you submit an application for this type of loan.
Do You Have an Asset That Qualifies as Collateral?
One of the first things you need to think about before applying for a secured loan is whether or not you have an acceptable asset to use as collateral. While you might own plenty of things that can be considered valuable, not all of them may be used as security to borrow money. Some of the types of assets that banks and other lenders accept for a collateral loan include the following:
Real Estate Property
One of the most common assets pledged by borrowers when taking out a collateral loan is real estate, such as an empty lot, a house, or a condominium unit. In order to proceed with the transaction, you need to show proof that you own the property. Usually, this comes in the form of a deed or title. You will have to surrender such documents to the lender, and you can only get them back once you’ve completely paid off the loan.
A Vehicle or High-Value Equipment
Another common collateral for secured loans is a vehicle. As with real estate properties, you’re going to have to surrender a proof of ownership of the vehicle before you’re able to take out the loan. For businesses taking out a secured loan, industrial vehicles and other high-value equipment may also be used as collateral.
Jewelry or Gold
Any jewelry made of genuine diamonds or gold can be used as collateral, although do note that higher carats are preferred.
Cash
If you have an active bank account, you can use cash as collateral for a secured loan. To do this, you need to take out a loan from your bank. You can then use this loan as collateral to borrow a bigger amount from a different lender.
Investments
Various types of investments, including stocks and mutual funds, can be surrendered as assets for a collateral loan. Make sure that you have proof of ownership, like a stock certificate, that you can hand over to the bank.
How Much Do You Want to Borrow?
A collateral loan may be the better option if you’re trying to borrow a huge sum of money, provided that you have a high-value asset. If the bank doesn’t deem your asset to be of equal or higher value than the loan, they might not approve your application or you might get a lower amount than you expected.
You should also consider the physical state of your intended collateral. The better its condition, the higher the amount of the loan it can possibly be approved for.
How Long Do You Have (or Want) to Pay for the Loan?
Both collateral and non-collateral loans usually have payment terms ranging from 1 to 5 years. However, you may have more leeway with a collateral loan. The interest rates are also lower because the risks are lower for the lender. Similarly, if you have a high-value asset, the interest may be even lower.
How Does Your Credit Score Factor in to Loans?
Some people have a difficult time getting approved for unsecured loans because they have a low credit score. If you have a low credit score or don’t have a credit history yet, you may have an easier time applying for a collateral loan. It’s not guaranteed that you’ll be approved, but the chances are definitely higher because the risk of the bank losing money is lower.
Are You Prepared for the Worst-Case Scenario?
A collateral loan is low-risk for a bank but high-risk for you because you may end up losing your pledged asset. While it’s not an inevitability, there’s always a possibility for the worst-case scenario of losing your collateral if you’re unable to keep up with your payments. To avoid this from happening, make sure to plan out your budget to include payments for your loan in advance.
Before taking out a collateral loan, make sure that you have a plan in place to pay off the full amount. After all, taking out a loan is a big responsibility, and thus, it’s best to be informed about your options so you can make the best choice. Hopefully, this article has helped you decide whether a collateral loan is a good option for your needs.
