Collateral Loans: Are They the Answer?

Sometimes we need cash fast. Emergency expenses, a sudden opportunity to get a great deal on something we want, or even needing to make a large purchase can all make us ask how we can get fast cash. If you have bad credit, or don't want to take out a traditional loan, collateral loans may come up as an option.

Unlike an unsecured loan, a collateral loan requires you to pledge a valuable asset, such as a car, jewelry, etc, in order to obtain funding from a lender.

If you have major expenses to cover like medical bills or an emergency car repair, leveraging your savings account, house or other personal assets can open the door to lower interest rates and more favorable loan terms. However, even though it’s possible to get collateral loans with bad credit, there are several drawbacks to consider.

So before you take out a secured loan with a credit union or online lender, learn more about the pros and cons of this personal finance option, how the loan application process works, and alternative routes to take if you don’t have the types of collateral needed.

What Are Collateral Loans?

Often called secured loans, collateral loans are guaranteed by something you own. Common types of collateral involved include:

• A car
• A savings account or a certificate of deposit (CD)
• Jewelry
• A home or other real estate asset
• Insurance policies
• An investment portfolio

If you fail to make the monthly payments, the financial institution that lent you the money has the right to claim the personal asset you pledged.

Types of Collateral Loans

There are several types of collateral loans you can choose from, including pawn shop loans. Depending on what personal assets you have, here are the loan options you could consider:

• Home equity loan: If cash flow is an issue, this type of loan uses the equity in your house and/or land to provide a one-time lump sum that can be used to cover a significant expense.
• Home equity line of credit (HELOC): This type of home equity loan allows you to withdraw funds on an as-need basis and pay the money back at a variable interest rate.
• Residential mortgage: Your house serves as the collateral. Defaulting on the loan payments can lead to homeowners losing their property in a foreclosure.
• Auto loan: A secured loan that typically involves lower rates, borrowers must make monthly payments or risk having their vehicle repossessed.
• Car title loan: This type of loan lets you borrow against your car title. However, car title loans usually come with high interest rates and fees.
• Personal loan: Although you typically can’t use retirement accounts, you can use your savings account or a certificate of deposit as collateral to cover necessary expenses.

Are Collateral Loans for Bad Credit Only?

Don’t have the cleanest credit report? Because a secured loan is backed by a borrower’s personal assets, lenders have more financial protection. That means that even if your creditworthiness isn’t ideal, you may still prequalify based on the collateral.

Online lenders, banks and credit unions will offer better loan terms if you have a higher credit score. However, you may still meet their eligibility requirements with a low score if you have a valuable asset to pledge.

One of the main advantages of collateral loans is for bad credit situations, but they can be useful for those with a stronger score as well.

Collateral Loan Benefits

Why might you want to take the collateral loan route?

Some of the advantages can include:

• Better repayment terms
• Larger loan amount
• Lower interest rates
• May be eligible even with bad credit history

Cons of a Personal Loan with Collateral

Lower loan rates are certainly a plus, but there are potential downsides to taking out a personal loan with collateral.

Some cons to keep in mind:

• Your eligibility is based on having valuable assets
• More complicated application process
• Risking personal assets if you default
• Damaging your credit score if you fail to honor loan terms

How to Apply for a Collateral Loan

If you believe a collateral loan is the best option based on your personal finances, you’ll need to go through with the application process. Be aware that it can be lengthy, so don’t expect to secure funds immediately.

In general, here’s what you’ll need to do get started:

1. Use one of the credit bureaus (Experian, Equifax or TransUnion) to check your credit score. You want to be as informed as possible about your financial situation before you proceed.
2. Attempt to prequalify with a few lenders, which will involve a soft credit check.
3. Compare your loan options, including loan terms and lender fees.
4. Collect supporting documents, such as bank statements, pay stubs and mortgage and tax documents.
5. Submit a formal application to a lender and wait for approval.
6. Receive your funds and use them for whatever expenses you have. It may take weeks to arrive, but if you obtain a secured personal loan with a savings account or CD, you may receive your money within one business day.

Alternatives to Collateral Loans

Taking out a personal loan with collateral isn’t necessarily the best choice for everyone. After all, it comes with significant risk.

Failing to honor the repayment terms can ultimately cost you your home, your car, a family heirloom, or another valuable asset.

So, if you rather keep your options open, here are other ways to get funding that don’t involve collateral:

• Credit card: Securing a line of credit is one alternative that can help you in a tough financial situation. A credit card issuer will determine the terms based on a number of factors, including your credit history and income.
• Unsecured personal loan: You may be able to get approved for an unsecured personal loan, but it’s important to remember that the eligibility requirements are stricter and you will pay a high interest rate.
• Family member or friend: Rather than risking your personal assets or dealing with a bank or credit union, you could borrow money from a trusted family member or friend. However, doing so could put your relationship at risk, especially if you are not able to pay that person back.
• Credit-builder loan: If poor or no credit history prevents you from qualifying for a secured or unsecured loan, a credit-builder loan can be a solid solution. The main downside to this type of loan is that you don’t get immediate access to the funds. Instead, the deposit from the financial institution must be paid back in installments before you can use the cash.

The Bottom Line

Collateral loans come with clear benefits and risks. On one hand, pledging your house or car can help you land a larger loan amount and lower interest rate.

However, you also run the risk of having to surrender a valuable asset if you don’t consistently make monthly payments.

Ultimately, if you practice fiscal responsibility and trust yourself to adhere to the loan terms, applying for a personal loan with collateral is a viable solution when money is an issue.

In the end, the choice is yours.