How to Use Collateral Loans to Borrow Against Your Assets

You can use collateral to help secure a loan. When you borrow money, you agree in writing that your lender can take your asset and sell it to get their money back if you fail to repay the loan. This minimizes the risk a lender has to take and maximizes your chances of getting approved at a good rate.

Understanding collateral

Collateral acts as a guarantee. Note that you lose your asset if you stop making payments on your loan. The lender can take possession of your collateral, sell it, and use the money to pay off the loan. Still, lenders prefer getting their money back. It is not like they enjoy taking legal action on you. The collateral is only a safeguard. The best scenario is that you pay the money you owe and keep your property.

There are several types of collateral. By law, it is an asset that is easy to value and turn into cash. For example, a savings account can be collateral, as well as vehicles, real estate, cash accounts, machinery and equipment, investments, insurance policies, valuables and collectibles, and future payments from customers. Personal assets can be pledged as collateral even if you are taking out a business loan.

How collaterals are valued

Often, lenders offer less than the value of your pledged asset, sometimes at a heavy discount, to improve their chances of getting all their money back in case your asset loses value.

If your pledged assets lose value for any reason, you might have to pledge additional assets to keep a collateral loan in place. You are responsible for the full amount you owe. If the bank takes your assets and sells them for less than your loan, you still have to settle the deficiency.

How collateral loans work

Collateral loans are often used in business loans, as well as personal loans. For many new businesses, collateral is required since they lack a history of operating at a profit.

In some cases, you get a loan, buy something, and pledge it as collateral all at the same time. This is the case for some premium-financed life insurance policies and home financing. The house secures the loan and the lender can foreclose it if you fail to make repayments.

But what if you have bad credit? It is still possible to secure collateral loans. However, these loans are expensive – only use them as a last resort. Car title loans are one example. You pledge your car as collateral and the lender can sell it if you fail to repay.

How to borrow without collateral

You have several options if you wish to borrow without pledging collateral. These include online loans, unsecured loans like personal loans and credit cards, and getting a co-signer to apply for the loan with you. The challenge is in finding a lender that will approve you. You will have limited choices and a higher rate to pay, too. Pledging collateral usually makes it easier to borrow money so explore this option first.