Collateral Loans

Collateral Loan: Should You Consider It?

Businesses wanting to stay afloat despite insecurities in the market would likely need additional funding and that is entirely possible with collateral loans. This financial product is offered to owners who want access to a considerable amount of money at affordable interest rates.

Securing loans with collateral provides a greater borrowing power and lower interest rates for you despite having a not-so-great credit score. However, these loans come with some risks that you should take into consideration.

New York Tribeca Group is a lending institution that offers collateral loans and other products for businesses. If you need to stabilize their cash flow or invest in a new opportunity, our agency can lend you a helping hand. We offer flexible terms and expert support that will suit your current financial status.

Do you need a collateral loan? Before you decide, here is a comprehensive guide that explains what this type of loan is and its pros and cons. This article also discusses other important information that can matter in your decision-making.

What are Collateral Loans?

Generally, loans can be one of these two types: unsecured or secured. Unsecured loans are offered to borrowers whose creditworthiness is considerably high. These loan products are often referred to as personal loans.

On the other hand, secured loans are available for people who pledge any asset with significant value to get approved for the loan. The amount you can borrow will depend on the value of the asset you put up as collateral.

What is collateral? It is the asset that the lender accepts to approve your secured loan application. It acts as a protection for the lender in the case that you default or fail to pay back your loan. Lenders can recoup the loss by seizing and selling the collateral.

Borrowers commonly put up these common assets as collateral when applying for loans:

• Residential and commercial properties
• Private vehicles
• Equipment and machinery
• Insurance policies
• Investments (i.e., bonds, mutual funds, fixed deposits, shares, employee stock ownership plan or ESOP)
• Collectables and other valuables
• Receivables or future payments from customers

Collateral vs. security

Collateral and security may get interchanged often, but they have key differences that make them two separate concepts. Here is a comparison of these two terms.

How Collateral Works

Before any lender approves collateral loans, they will inspect whether you can repay the loan. That is the main reason why many lenders require some sort of security or collateral. It is asked of you to ensure that you can keep up with your financial obligations.

When the lender wants to lessen the risk of losses, they will typically require collateral from the borrower. If you pledge your asset, the lender acquires rights to act should you fail or stop making repayments. 

If you default on your loan, the lender is legally allowed to seize your assets and sell them. They can use the money from the sale to cover the unpaid portion of your loan. If there are any balances remaining, the lender can then pursue legal action to recoup their losses.

Loans with security are usually available at much lower interest rates compared to unsecured loans. The lender can legally claim the collateral put up by the borrower, which is referred to as the lien. If you avail yourself of collateral loans, you will also have a compelling reason for repaying on time since you could lose your valuables if you fail to meet your obligation.

Despite popular belief, lenders prefer borrowers to repay loans on schedule since legal action can eat up too much time and money. Seizing and selling the collateral is usually done as a last resort. However, assets as security are the lender’s most appropriate form of protection.

What are the Types of Collateral?

For you to get a better chance of acquiring loans successfully, you need to know various collateral types that you can offer as security.

• Real estate. Borrowers commonly put-up properties such as parcels of land or their house to secure a loan. These assets are high value with a low depreciation rate, making them the ideal collateral. However, it comes with a lot of risk for the borrower.
• Cash security. Money is perhaps the easiest and simplest form of collateral. The borrowing business or owner can present their bank account as collateral. If they default, the lender can liquidate the account to recoup the loan amount.
• Inventory financing. Collateral loans may also involve a business’ inventory to serve as pledge. If the borrowing entity stops making repayments, the lender can sell the listed items from the inventory, such as equipment and machinery, to make up for their losses.
• Invoice collateral. Small businesses can apply for a loan by using their outstanding or unpaid invoices as collateral. 
• Blanket liens. Lenders may also choose a lien as a fallback, which is a legal claim that gives the lending agency the right to dispose of the business asset when the loan defaults. 

Types of Collateral Loans

In essence, loans can become secured loans if there is acceptable collateral put up by the borrower. Most lenders choose collateral that can easily be valued and turned into cash such as a savings account. It’s easy to check how much it is worth and it is simple to collect.

Here are some common categories of collateral loans.

Mortgage

A home loan or mortgage is one of the most common secured loan types. This loan is backed by the property being financed. If you get a mortgage and fail to pay for at least 120 days, this loan can default and lead the lender to foreclose your property to make up for the losses.

Home Equity Loan

Borrowers taking a second mortgage may put their home as collateral. A home equity line of credit or HELOC allows you to borrow money against your property’s equity, which pertains to the difference between the current value of the home and the remaining mortgage owed. 

For example, if the house is $200,000 in value with a remaining mortgage of $100,000, you can apply for a second mortgage for as much as $100,000. 

Vehicle Loan

Vehicle loans can be used to purchase a car, motorcycle, truck, boat, or even a private plane. Like a mortgage, the auto loan uses the financed asset itself as collateral. If you fail to meet the repayment terms, the vehicle can be repossessed by the lender.

Car Title Loan

You can put your car title for collateral loans with smaller amounts and shorter terms. The car title loan often has only a 30-day repayment schedule and incurs fees with high-interest rates. Defaulting on this loan can mean that the lender seizes your car. As an alternative, expert advisors may tell you to get a credit card cash advance or a small personal loan rather than this type.

Personal Loan

You can use personal loans for a variety of reasons, including consolidating debt on credit cards or paying for big-ticket items. A secured personal loan gives you access to higher borrowing amounts and lesser interest rates. Some of the most common collateral for this loan type include certificates of deposit (CD) and personal savings accounts.

Margin Trading

Investors may also use collateralized loans in margin trading. They could buy shares by borrowing money from their broker with their balance in the brokerage account as security. With this loan, the investor can increase their number of shares, which could multiply their potential gains if the shares appreciate.

However, this possible exponential gain comes with multiplied risks, too. If the share value decreases, the broker may demand the investor to pay the difference with the brokerage account as the fallback.

How are Assets Valued?

The amount you can borrow is typically lower than the value of the collateral. In some cases, the pledged asset could be heavily discounted. For instance, the lending agency may only consider 50% of your investment portfolio as collateral. This tactic lessens the risk for the lender if the loan defaults.

For collateral loans, you can be quoted an appropriate loan-to-value ratio or LTV. If your collateral is a house valued at $100,000, you might be allowed an 80% LTV. It means that you can apply for a loan of up to $80,000. 

Some assets may lose value over time. If your collateral depreciates for any reason, you may have to pledge additional assets to keep your loan in place. You will take full responsibility for your loan even when the lender sells your property for less than the loan amount. 

If you refuse to comply, the lender may seek legal action against you to recoup the remaining amount that did not get paid off or the loan deficiency.

Where Can You Find Collateral Loans?

Most financial institutions can offer secured loans. The only differences are the varying terms and interest rates from one lender to another. You can approach these types of lenders if you want to apply for a collateral loan.

National Bank

Large banks typically have the most financial services and are convenient for every borrower because they have branches nationwide. You can ask about your options for the right secured loan product from a national bank if you are already their existing customer.

Community Bank

Local banks may be small, but they also offer various services for customers in the locale. Since they compete with bigger banks for business, community banks often provide more competitive terms for their customers, both in loans and deposits.

Credit Unions

Nonprofit credit unions are financial cooperative institutions where the owners are the members themselves. If you are a member, you can avail yourself of collateral loans with attractive terms and low-interest rates. 

Membership in credit unions is usually based on where you live or work, which school you went to, and your religious affiliation. You are also expected to maintain a share or savings account within the co-op.

Auto Dealerships

Automakers can offer loans for a new car purchase through their authorized dealers. The rates offered by this lender are typically competitive compared to credit unions or banks. However, the interest rate is largely dependent on the borrower’s credit rating.

Pawnshop Loans via Storefronts

Pawnshop loans are usually short-term and require you to secure funds into your checking account. If you borrow from this lender, you can already expect significantly higher interest rates.

Online Lenders

If you don’t have access to borrowing opportunities from banks or credit unions, you can take your chance with online lenders, which offer products that may not exist locally. They operate via the web and often have less overhead than traditional financing institutions. As a result, they might provide better interest rates and terms for you. 

You can easily check the requirements for collateralized loans offered by online banks through their website. New York Tribeca Group has detailed pages for the loans we offer with information on terms and potential rates for you. 

Before you submit your loan application, you can check if you prequalify without having to go through with a hard credit inquiry directly.

Collateral Loans: Pros and Cons

Here is a closer look at the advantages and disadvantages of this loan type.

Pros

They aren’t based solely on credit rating

Unlike unsecured loans, the collateral loan does not see the credit history of the borrower as a huge factor. The act of pledging a property or asset already offsets the lender’s risk when offering this type of loan.

If you want to apply for a secured loan, you can still be approved even if you have a limited credit history or if your credit score is less than stellar. There may also be plenty of borrowing options depending on the collateral that you put up.

They allow you to potentially borrow more money

Pledging a property or asset gives the lenders a way to recoup anticipated losses if a loan defaults. If you offer sizable collateral, the lender might be more inclined to offer you a higher loan amount. It’s an assurance that you have the capacity to repay the money you owe and at the same time provide a safety net for the lender in case you fail to meet your financial obligation.

They commonly have lower interest rates

If you look closely into unsecured loans, you will notice that the interest rates are sky-high compared to collateralized loans. Lenders usually treat the latter as less risky than unsecured loans. As such, you may be able to find collateral loans with a lower annual percentage rate (APR). That means you can find a loan with interest rates that agree with your preference and budget.

They provide short-term liquidity

Your money will usually be tied up with an asset, which cannot be converted to cash easily. As opposed to selling your property to get funding for a specific purpose, you can use these assets as collateral instead. This way, you can get money without the hassle of finding a buyer for your valuables, which could take a long time to process.

They can help build your credit

Having a less remarkable credit history can be a disadvantage, especially for business owners. If you have little to no credit profile, you may not be eligible for some loan products or financial services. When you avail yourself of a collateral loan and repay your dues diligently, you can gradually build a good credit history for yourself.

If you want to apply for a secured loan for this purpose, you must make sure that the lending agency reports and updates your payment status to the primary consumer credit bureaus.

Cons

You can lose your property or asset

Defaulting on a loan or failing to pay the minimum amount according to your repayment schedule can prompt the lender to seize your collateral. It is by far the biggest risk of secured loans. Your asset can be repossessed, whether it’s your house, vehicle, or the money in your bank account.

Application and approval can be complicated

Before you can successfully acquire a collateral loan, the lender must value the asset that you pledge as collateral. This process can be time-consuming and could prompt the lender to ask for additional information and documents from you. 

You need to pledge an acceptable asset

Just because you have something of value does not mean that you will automatically be approved for a collateral loan. Banks and other financial institutions will thoroughly investigate the property or asset you put up before they can determine if you qualify or not. 

In contrast, unsecured loans can be acquired without promising any collateral in return. However, if your application for an unsecured loan is denied, you might also find it tougher to qualify for a collateralized loan.

Applying for a Collateral Loan

If you determine that a collateral loan is what you need after weighing your options, then you can start applying for one. How can you do that? Here are some of the essential steps to get your loan application approved. 

Keep Your Credit Score in Check

Financial institutions can still offer you a secured loan even if your credit history is little to nonexistent. However, having good credit can mean better repayment terms and lower loan rates for you. You can check your credit report online and find any negative marks or errors that should be fixed and make it ready for your loan application.

Prequalify with the Lenders

Interest rates and other components of the secured loan can vary from one lender to another. Therefore, it is ideal to compare offers from different lenders and find which one suits your most pressing needs. 

You can check with the lender if you can prequalify for a collateral loan before officially submitting your application. This process usually involves a soft credit check on you, which will not affect your credit standing in any way. You can undergo prequalification with at least three lending agencies to see your options.

Compare Offers

Once you choose the best lender that can provide you with the right product, the next step is to compare their offers. You can take note of the loan repayment terms and fees that the lender may charge throughout the application and approval processes.

Choose Your Collateral

For home or vehicle loans, the collateral is usually the property being financed. However, other secured loans will require you to choose the most acceptable asset with the right value to cover the loan amount you wish to secure. To get a better chance of qualifying, you can choose an asset that is liquid and easy to access. For example, funds in a bank account are some of the best types of collateral for lenders.

Gather Your Documents

If you have ironed out the details of the above steps, you can start to secure the necessary documents that the lender might ask from you. It’s essential to have a copy of your income statements, financial holdings, and documents pertaining to your other existing debts. 

The lender may also ask you for your pay stubs, bank statements, W-2s, tax documents, and any mortgage documents under your name. The same goes for borrowing businesses—you should prepare all the financial documents beforehand to make the application process hassle-free.

Submit a Formal Loan Application

Depending on the lender, you will usually be required to fill up a loan form and submit the documents and other requirements for the application. You must also be ready to be asked for supporting documents if the lender finds your submitted paperwork inadequate.

Once you formally apply, you must expect the lender to perform a hard credit check on you. It involves thoroughly inspecting your credit reports. This step typically has a temporary yet minimal impact on your credit standing.

Collect Your Money

Again, the loan application and approval process can vary for different lenders. Others may be quick to provide the cash you need, while some may take weeks before you will be invited to sign the closing documents. 

Collateral Loan Alternatives

It is generally easier to apply and qualify for collateral loans if you have any property or asset to pledge. However, if you find it uncomfortable to manage the risk of losing your valuables due to a default of your loan, there are still other loan products for you.

Here are some of the alternatives to collateralized loans that you can consider.

Unsecured Personal Loan

Some lenders can provide you with an unsecured personal loan if you have no assets to back your application. It involves a legally binding contract that states your promise to pay the loan back according to the repayment terms. Failing to do so can be detrimental to your credit rating, and consequently makes other loan options unavailable for you in the future.

Unsecured loans are perfect for you if you don’t want to pledge collateral. However, these loans have much higher interest rates and stricter qualification requirements. It is also treated as a riskier loan option by lenders.

Credit-Builder Loan

If by any unfortunate circumstance you fail to qualify for secured or unsecured loans due to poor credit standing, you don’t have to lose all your hope. Credit-builder institutions like credit unions can deposit money to a bank account, which they can hold until the loan term ends. You repay the union by depositing money in installments. 

When the term ends and you have duly paid the amount back, you can then get the cash. Furthermore, your credit activity is reported back to the primary credit bureaus. The downside to this loan type is that it doesn’t provide you with immediate access to funding.

Using a Co-Signer or Co-Maker

In some cases, you can assign another individual as a co-maker or co-signer as a type of security instead of a property or asset. If you default on your loan, your co-signer will shoulder the responsibility of repaying the loan. 

Most lenders will choose a co-maker who has a higher credit score than the borrower. If you have little to no credit history, this type of loan could be a viable option for you.

Friends or Family

Borrowing from your friend or family member is another alternative to collateral loans that do not require you to credit on a loan or risk your assets. However, the drawback to this option is the potential risk to your personal relationship with the person you’re trying to borrow money from. If you are unable to pay your debt in time, you might struggle to maintain a good rapport and impression with them.

Before you borrow from someone you know, make sure to think about it carefully. Is it a realistic option for you? It’s not worth losing your connection with a friend or family because of debt.

FAQs

Can You Use Collateral for Down Payment?

Down payments are usually 20% of the total loan you expect to secure. For this, you can pledge assets like gold, stocks, or other properties to pay for the down payment if necessary. Beforehand, your assets will be appraised to determine if they are worth as collateral for your loan.

What Happens When You Default on a Loan?

When you miss your payments on a loan, the lender may consider it to be in default just 30 days after your past due date. However, the number of days varies from one lender to another. Many lending agencies provide a grace period that allows you to keep up with your repayments. During this time, your loan can be branded as delinquent.

Lenders may reach out to you if you have a delinquent loan so that you can agree on an acceptable payment plan before it goes into default. If you cannot meet the terms, you can potentially lose your assets since the lender can sell them to recoup their losses. 

You can read the fine print of your contract and read the state laws to know what exactly happens to your collateral loans that go into default.

How Much Should You Take Out?

When seeking collateral loans, it’s important that you borrow only within your capacity. You can apply for a loan that will cover your immediate need; you may also add a little extra for unexpected fees and charges that come your way. 

It’s very tempting to borrow a large sum of money, especially if your collateral allows you to apply for higher loan amounts and better interest rates. However, it may not bode well for your business in the long run—you could have trouble paying on time while keeping your cash flow healthy because of the loan.

Is it Worth Applying for a Collateral Loan?

Like all other loan types, collateral loans come with risks that you must be aware of before you go ahead with your application. There is a huge possibility of losing your asset once you default on your loan. However, if your financial status is secure, then a collateral loan can be good for your business and credit standing.

If you are ready to apply for a collateralized loan, you can reach out to our experts at New York Tribeca Group to discuss what loan products will suit your preferences and needs. Our goal is to aid you financially in growing your business, giving you the opportunity to reach your targets and realize your dreams.