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What is Collateral?

Learn more about what collateral is, why some lenders require it, and what types you may be able to use for your next loan.

Collateral is anything used as security for payment of a debt or performance of a contract. When taking out a loan, you offer collateral in exchange for a loan. Also known as secured loans, this type of funding is less risky for a lender than unsecured loans.

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If you need cash for some unexpected reason, taking out a loan can be a lifesaver. However, sometimes getting a loan can be difficult, especially with poor credit history and no job. If you are in this situation, this type of funding could meet your needs.

Why do Some Lenders Require Collateral?

If you fail to repay a loan, the lender can take your valuable item in place of the money you owe. As a result, this arrangement usually has lower interest rates and offer higher dollar amounts than unsecured loans. With mortgages, the home itself secures the loan. If a homeowner fails to pay the mortgage, the bank may eventually seize the home in place of payment.

Types of Collateral

The amount offered through a secured loan is never more than the value of the asset used to secure the loan. This value is assessed at a ‘fair market value,' not the retail price or the current value. Lenders determine the value of what you use to secure the funding based on depreciation of an item and how much they can sell it for to cover the loan if you default. In general, the loan amount will be less than what you paid for the asset when it was new. If you are thinking of taking out this type of funding, here are some ideas for assets:

●Electronics - Stereos, home theater systems, TVs, computers, mobile devices and other electronics.

●Jewelry - Gold, platinum, silver, diamonds and other types of precious stones.

●Valuables and collectibles - Family heirlooms (antiques, jewelry, etc.), coins and currency, stamps, pop culture collectibles (comic books, baseball cards, etc.) and other valuable items.

●Money - Savings accounts or money that you’re contractually obligated to and will receive in the future.

●Investments - Stocks, bonds, and mutual funds shares can be used to secure the loan so that a person can get money without selling their investments. Loans from investment firms typically have lower interest rates and take less time to process than traditional loans.

●Vehicles - If you own your vehicle outright, using it as collateral is straightforward. The lender estimates the current value of the vehicle then offers to loan you anywhere from 60 percent to 70 percent of its value. If you don’t currently own your car but have equity in it, you might be able to take out a loan. However, you need to owe less than the vehicle’s value.

●Machinery and equipment - Computers and other office equipment, restaurant equipment, tractors, and other farm equipment, construction equipment and other types of machinery. Like vehicles, the loan amount correlates with the value and the equity you have in the equipment and is usually around 70% of the asset’s value.

●Real estate - Homes, land or commercial property are often used to obtain larger loans. Home-equity loans are a percentage of the equity you have in the home, usually around 85 percent of what you’ve already paid on the property.

Dangers of using Secured Loans

Taking out a loan may be a good way to get money to cover needs such as unexpected medical bills and vehicle repairs as well as things like home repairs and even money to start a small business. However, there are some dangers to be aware of when borrowing money.

●Losing your most valuable assets - As stated above, failing to repay your loan could result in the lender taking the assets used to secure the loan. This might not be as severe if the item is a TV or a gold chain. But if you use your vehicle or your home to secure the loan, losing it is much more serious.

●Losing investments - Using stocks and bonds to secure a loan may cause trouble if the investments lose value. In this scenario, the lender could ask for more collateral or simply sell the assets.

●Losing money - If you borrow money using a savings account or money you will be paid in the future, there is the possibility that you could lose these funds if you are unable to repay the loan.

Borrow Wisely

If you have a valuable asset, it is relatively easy to get a collateral loan. However, taking out this type of loan involves a certain amount of risk for you. Whatever the reason is that you need money, be sure to borrow wisely. Borrow for good reasons and don’t borrow more than you need or you may risk losing assets. Lastly, if you feel nervous about using your assets to secure a loan, it may not be the best option for you.