Introduction
Planning to buy a property? You should know the difference between mortgage and collateral. These two terms are thought to be the same but they have different meanings.
Collateral is what you offer to the lender to secure any loan. A mortgage, on the other hand, is a loan. The property here is the security that you buy. The difference between collateral and mortgage can help you choose the right option for your needs.
What is a Mortgage?
A mortgage is the loan that you use to buy a property. Learn how it works in the points:
1. A mortgage lets you buy real estate without paying the whole price upfront.
2. You repay the borrowed amount and interest over a set number of years until you fully own the property.
3. Most mortgages are paid in regular instalments where the payment amount stays the same, but the share of principal and interest changes over time.
4. You can take a mortgage for a long period, often up to 30 years, or it can be more in some cases.
5. The property in a mortgage you buy is used as collateral for the loan.
Types of Mortgages
Here are the types of mortgages mentioned in the tabulated form:
Mortgage Type | What Is It | For Whom |
Fixed-Rate Mortgage | The interest rate stays unchanged for the entire loan period. | It is for those who prefer steady monthly instalments. |
Adjustable-Rate Mortgage | Loan rates shift at set times depending on market changes. | Borrowers who expect rates to fall or plan to switch loans. |
Reverse Mortgage | Let senior homeowners turn home value into cash without selling it. | Retired people who want regular funds without giving up their home or assets. |
Commercial Mortgage | A loan used to buy or refinance spaces for business, such as shops or offices. | Entrepreneurs looking to grow or purchase business property. |
Interest-Only Mortgage | Pay interest only for an agreed time, then start full payments (which include interest added to the principal). | Property investors are selling before principal payments begin. |
The Role of a Mortgage in Securing a Loan
A mortgage plays an important part in getting a loan, especially for big purchases like a home or office. It is a legal contract that protects both the person borrowing and the lender.
Here's how it helps:
1. Get Access to Large Loan Amounts -Mortgages suit high-cost needs such as buying a house or business space. The property's value decides the loan size. It offers borrowers access to the required amount of funds.
2. A Stable Choice for Lenders - Using property as collateral offers security for lenders (since property prices often rise over time). This lowers lender risk while making it a great choice for banks as well as finance companies.
3. Repayment Terms are Long -Many mortgages let people repay the amount between 10 & 30 years. Thus, it helps borrowers manage the loan in smaller instalments over the long run.
4. Agreement Binded by the Law - A mortgage is backed by law. The buyer cannot sell the property or change the ownership without the lender's approval until the loan is fully paid. This way, it protects the lender's interest.
5. Lenders Have Foreclosure Rights -When a buyer misses a payment, the lender may ask for the foreclosure charge to recover the money. It may take time, but it offers a way to get the funds back.
6. Example of a Mortgage -Suppose you buy a home for ₹45 lakhs & take a mortgage of ₹30 lakhs, the home is the security. You repay in monthly instalments for 15 years. The home is fully yours once it is complete.
Impact of Default on Mortgages
1. Foreclosure Process - The lender may begin foreclosure if a borrower fails to pay. It is a legal step to take over the mortgaged property. The property is then sold, and the money earned is used to pay off the remaining loan balance.
2. Borrower's Loss - The borrower gives up ownership of the property. Any equity (difference between the property's worth & the loan still due) may be returned after the lender's amount is cleared.
3. Legal & Financial Repercussions - Foreclosure can lower the borrower's credit rating. It makes it harder to get loans in the future. Court costs as well as delays can also increase the financial strain of the borrower.
Cons of Mortgages
1. Financial Commitment for a Long Time -Mortgages often span between 10 and 30 years. It needs steady financial discipline for multiple years.
2. Foreclosure Risks -Missing mortgage payments can result in foreclosure. As a result, it may lead to loss of both the property as well as any equity.
3. Market Value Fluctuations -A drop in property value can leave borrowers owing more than the current market worth of the asset.
Check Out Personal Loan Foreclosure Calculator !
What is Collateral?
Collateral is an asset you pledge as security for a loan. Here's how it works:
1. Loans backed by collateral are secured loans.
2. The lender can take the asset & recover the amount if you fail to repay.
3. The collateral's value is enough to cover the loss to the lender when repayment fails.
4. Assets like property or vehicles (or investments or gold) may be used as collateral.
5. The property bought with the loan in a mortgage serves as the collateral.
Read Also: Collateral Free Loans in India
Types of Collateral
Here are the types of collateral explained in the table below:
Collateral Type | Description | Common Loan Uses |
Real Estate | Land or houses (any commercial spaces) pledged as loan security. | Mortgages or business loans. |
Vehicles | Cars, trucks, or similar vehicles are given as collateral. | Auto loans or secured personal loans. |
Gold | Gold jewellery or bullion pledged for instant or short-term funds. | Gold loans, personal loans. |
Financial Instruments | Fixed deposits, stocks, bonds are offered as security. | Margin loans, secured personal loans. |
Inventory/Equipment | Machinery, raw materials, as well as stock-in-trade, are pledged. | Business loans or working capital loans. |
Accounts Receivable | Pending invoices are used as security for short-term loans. | Invoice financing or factoring. |
The Role of Collateral in Securing Diverse Loan Types
Collateral is a flexible tool for getting instant personal loans in many financial situations.
Here's how it works:
1. Asset Type Flexibility - The role ofcollateral in loans can be any valuable item, unlike mortgages. They are not tied only to property, unlike mortgages. Common examples are:
a. Movable Assets -Vehicles, Gold and Machinery.
b. Financial Instruments -Stocks, Fixed deposits and Bonds.
c. Personal Assets -Jewellery or Valuable collectibles.
This variety lets borrowers use different assets to access credit.
2. Can Secure Various Loan Purposes - Collateral is used to back loans for multiple needs:
a. Gold Loans -Borrowers pledge gold for short-term funds.
b. Auto Loans -The car or vehicle itself acts as security.
c. Business Loans -Machinery or inventory often serves as collateral.
Take the example of a business owner who may pledge factory equipment to get financing for expansion.
3. Loan Depend on Asset Value -The amount lent is usually a percentage of the collateral's current value. For instance:
a. A gold loan might provide 75-90% of the gold's market value.
b. A car loan might cover 60-80% of the vehicle's resale price.
It ensures lenders can recover their funds when repayment fails.
4. Speedier Approvals of Loans -Secured loans often have simpler approval steps than unsecured loans (since the asset gives lenders confidence). This results in speedier disbursement.
5. When the Borrower Defaults -Suppose a borrower cannot repay. In such circumstances, the lender can sell movable assets or financial instruments to recover the debt. That makes secured loans a practical option for both sides.
6. An Example of Collateral -The best example is a farmer who needs money for crop planting. The farmer may pledge gold jewellery to secure a loan. Note that it is not a mortgage. Thus, the farmer may get credit without going through lengthy legal steps.
Impact of Default on Collaterals
Here's the image of the default on collaterals before you learn mortgage vs collateral difference:
1. Seizure of Collateral -Lenders can take possession of the pledged item (such as gold, vehicles, stocks, etc.) depending on the asset type. One does not need to go through lengthy court processes.
2. Easy Liquidation -Movable assets like gold or vehicles are sold to cover the outstanding loan. The lender can directly collect the proceeds for financial instruments.
3. Financial Loss of the Borrower -The borrower forfeits ownership of the pledged asset. The additional amount may be returned to the borrower if the asset's value is higher than the loan amount.
4. Nominal Legal Involvement -Recovering collateral usually requires fewer legal steps compared to foreclosure. This is more impactful, especially when dealing with movable assets.
Cons of Collaterals
1. Value Depreciation -Movable assets such as vehicles or machinery can lose value over time. That may reduce the amount recovered by the lender.
2. Restricted Use of Assets -You cannot sell or use the pledged collateral without the lender's approval until the loan is fully cleared.
3. Asset Seizure -The lender can take back the pledged item if the borrower fails to repay. This is regardless of whether it is a vehicle, gold or stocks.
How does Mortgage and Collateral work?
As per collateral vs mortgage, a mortgage is the loan you take. On the other hand, collateral is the security you give for that loan. Here's how the two work together:
1. You pledge collateral, most often the property you are purchasing, when you take a mortgage.
2. The repayment is made in instalments over a set period. It covers the principal as well as the interest.
3. You can get complete ownership of your property once you pay the mortgage in full within the agreed tenure.
4. The lender has the legal right to take possession of the property to recover their funds when you cannot repay within the repayment term.
Understanding these aspects may help you distinguish between collateral & mortgage. You can apply for a personal or home renovation loan from lendingplate if you need financing for a property or other purposes. Get speedy disbursal of your loan amount within 30 minutes of approval.
Difference Between Mortgage and Collateral
The following are the differences between mortgage and collateral depending on a few aspects.
Let's find out from the table below:
Aspect | Mortgage | Collateral |
Definition | A loan arrangement where real estate serves as security for repayment. | Any valuable asset pledged to secure borrowing |
Ownership | The borrower keeps ownership but cannot transfer or sell without the lender's approval. | The borrower owns the asset but risks losing it if they fail to repay. |
Purpose or Use | Used solely for loans involving real estate or property purchases. | Applicable for multiple loan types, such as personal or business loans (also auto loans). |
Amount of Loan | Larger loan amounts are tied to the market value of the property. | Loan size is based on the asset type as well as current valuation. |
Loan Tenure | Typically long-term & range between 10 & 30 years. | Short to medium-term: it all depends on the loan as well as the asset category. |
Type of Asset | Fixed assets like homes or plots (or even commercial spaces). | Can include both fixed as well as movable assets (such as cars, jewellery, stocks, machinery, etc). |
Lender's Risks | Lower risk as real estate generally retains or grows in value. | Higher variability since asset values like stocks or vehicles can fluctuate. |
Process of Recovery | Requires foreclosure (usually a lengthy legal process). | Movable assets can be seized & sold more speedily. |
Documents Required | Involves detailed legal steps such as property registration as well as lien creation. | Depends on the asset type. It is simpler for movable items like gold or vehicles. |
How to Reclaim Mortgage and Collateral Assets?
The process for recovering collateral & foreclosing a mortgage varies in speed as well as complexity when a borrower fails to repay.
Here's an outline:
Reclaiming Collateral
1. Seizure of Collateral - The lender takes possession of the pledged asset. It is often speedy & needs little legal involvement for movable assets like gold or vehicles.
2. Asset Liquidation - The lender sells the asset to recover the loan amount. Any extra funds after repayment are returned to the borrower.
3. Timeline - Recovery or sale of collateral is usually faster (more importantly for physical items or financial holdings).
Foreclosing a Mortgage
1. Borrower Gets a Legal Notice -The lender sends a formal notice to start the foreclosure process.
2. Proceedings of the Court - Foreclosure needs court approval to sell the mortgaged property. This can take considerable time & add costs for both sides.
3. Auction & Sale - The property is auctioned, and the proceeds go towards clearing the debt. Any remaining amount after repayment is returned to the borrower.
4. Timeline - Mortgage foreclosure often takes far longer than collateral recovery. It may sometimes stretch over months or years because of legal steps.
Why Collateral is Popular in Non-Mortgage Loans?
Considering the difference between mortgage and collateral, collateral is a common choice in non-mortgage lending as it is flexible & easy to use. Listed below are the reasons:
1. A Varying Range of Asset Options -Collateral can be gold, vehicles, or financial assets, unlike a mortgage. It makes it available to more people.
2. Speedy Processing - Loans backed by collateral (such as gold loans) are approved faster since the risk for the lender is lower.
3. A Higher Amount of Loan -You can borrow up to 75-90% of your asset's value (depending on the type of loan).
4. Reduced Interest Rates - Lenders often give better rates since the loan is backed by an asset.
5. For Low Credit Scores - Collateral lets people with average or poor credit history still get loans.
Also Read: Difference Between Loan and Mortgage
Conclusion
Now you know the difference between mortgage and collateral. A mortgage is tied to property & involves longer terms. On the other hand, collateral can be many asset types & is often speedier to process. If you want funds without waiting long, a loan with collateral might suit you. For property-related needs, a mortgage is the common choice.
Frequently Asked Questions (FAQs)
Q.1. Is every mortgage backed by property as security?
A mortgage always uses property as security. The property stays in your name, but the lender can take it if you fail to repay the loan.
Q.2. Does the property used in a mortgage serve as a backup for the loan?
The property works as a backup for the loan. The lender can claim the property to recover the pending loan amount if you do not repay.
Q.3. How are a pledge, collateral, and mortgage different from each other?
A pledge is for movable goods, collateral can be any asset, and a mortgage is when property is given as security for a loan.
Q.4. What happens if I can't repay my mortgage?
The lender can start legal action to take your property or sell it (or use the amount) to recover the loan if you fail to repay your mortgage.
Q.5. Does having collateral help me get a bigger loan?
Offering collateral can help you get a bigger loan because it reduces the lender's risk. It results in higher amounts as well as better repayment terms for you.
