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An individual can apply for a secured loan with a higher amount and a lower interest rate with the help of collateral. Borrowers put up collateral like a valuable item, home, or savings account as their collateral. Generally, there are two types of loans available – secured and unsecured loans. In this post you'll learn about the role of collateral for loans.
A secured loan is one where borrowers pledge collateral or assets as security against that loan. Suppose the borrower defaults on that loan. In such cases, the lender can seize their collateral and sell it to recover their outstanding balance.
This post helps you understand the ins and outs of collateral in secured loans. So, before understanding what collaterals in loans are, here's how a secured loan works.
A secured loan is backed by collateral that the borrower offers. In such loans, the amount doesn't exceed your collateral's value. Your collateral serves as security for your lender to get their outstanding balance in case of default. Moreover, these loans come with reduced interest rates and higher loan amounts. These collateral loans follow a structured repayment plan that includes the following i.e. interest rate, loan tenure and the monthly amount of payment.
Any secured loan works on collateral security. Suppose a borrower applies for this loan. As soon as the lender sees the application, they evaluate the creditworthiness and value of the collateral. These two aspects determine the borrower's personal loan eligibility.
Now, suppose the value of the collateral for the loan is more than the amount of the loan. Interestingly, the borrower also has a great credit score and a decent monthly income. In such cases, your lender immediately approves your loan and disburses the amount.
A borrower must agree to repay the amount within the due date with interest and other fees. Any repayment failure may result in losing the collateral. Alternatively, the lender or bank may offer you an extended time period to repay the amount.
If you fail, the lender recovers the outstanding balance by selling your collateral. That's how a secured loan works. So, from the above, it is clear that collateral has a major role in secured loans. However, you don't need collateral for personal loans, as they are unsecured loans. So, let's find out what collaterals are from the following point.
Collaterals are a borrower's assets pledged as security for a loan. It can be anything from a home, gold jewellery, or even a car. Its value is greater than the loan amount to offer sufficient security to the lender. The following are the benefits of using collateral for loans:
1. Reduces Risks for Lenders: Accepting collateral helps lenders reduce risks in case of default.
2. Lower Rate of Interest: Collaterals for loans have lower interest rates.
3. A Seamless Approval Process: Collateral can increase loan approval chances, especially for borrowers with bad credit history.
4. A Higher Amount of Loan: Collateral acts as the security, so lenders are more willing to offer a higher loan amount.
Collateral loans are built on a secured lending model. The borrower gives an asset as a guarantee. The lender evaluates its market value before deciding the loan amount using the LTV ratio.
The borrower repays the principal & interest according to the agreed schedule after approval. Until the loan is cleared, the pledged asset stays under the lender's charge. The lender can sell or take over the collateral to recover any due if repayment isn't made.
Collateral loans are commonly available against property, gold, securities, as well as fixed deposits. The approval process usually involves checking personal loan documents, valuing the asset, and finalising the agreement. The collateral is released & ownership returns to the borrower once the loan is paid in full.
Collateral loans take various forms depending on your pledged asset. Here are the common examples that include the following-
1. Loan against property: This is often used for business funding, large personal needs or even education.
2. Loan against securities: Shares, bonds, or mutual funds can be pledged to raise liquidity without selling investments.
3. Loan against fixed deposits: Banks allow loan against FDs at lower interest rates while keeping savings untouched.
4. Machinery loan: Businesses may pledge equipment to obtain funds for expansion or operations.
5. Gold loan: Pledging gold coins or ornaments offers speedy access to cash (usually for short-term needs).
6. Auto loan: The car itself is the collateral in this case until the loan is completely repaid.
Securities are generally classified into two categories: primary & collateral. A primary security refers to the asset that comes into existence as a direct result of the loan facility provided to the borrower. Any additional asset pledged in support of the loan is termed collateral security.
Take a housing loan, for example. The house you purchase is the primary security since it is funded by the loan. But a fixed deposit offered by a borrower can strengthen the lender's assurance as an FD serves as collateral security.
The charges for collateral loans differ among lenders. Note that they depend on the loan type – be it against a property or gold (even a vehicle or a fixed deposit). Typical charges may include personal loan processing fees, valuation costs, or legal checks. Still, collateral loans are secured. The interest rates are generally lower than the ones for unsecured loans.
The cost of borrowing against collateral depends on the type of asset pledged and the loan category. Assets with higher or more stable value usually attract lower interest rates.
| Loan type | Collateral | Typical rates |
|---|---|---|
| Mortgage | Home | ~6.94% APR (30-year fixed) |
| Home equity loan | Home | Starting at 6.88% APR |
| Car loan | Vehicle | From 4.09% APR |
| Car title loan | Vehicle | Nearly 300% APR |
| Personal loan | Savings, FD, or other | Up to 36% APR |
A wide range of assets can be used as collateral for loans.
These include:
1. Vehicles and machinery: Movable assets like cars or business equipment can be pledged if they carry resale value. In some cases, lenders may even take possession of the asset until the loan is settled.
2. Gold & valuables: Gold jewellery is accepted as collateral. You can also use gold coins or bars. Items such as antiques or fine art pieces might be considered as well.
3. Property & land: Real estate is a preferred form of collateral as it offers a high & stable value.
4. Investments: Stocks or bonds might be pledged to secure a loan while retaining ownership of the investment. You may also use mutual funds or sovereign gold bonds.
If you want to opt for secured collateral loans, you can use any of these types of collateral to apply for the loan. Note that collateral requirements may vary from one lender to another. You can get benefits based on the type of collateral you choose.
You may use your property or real estate to secure your loan. It's a common practice for business loans and instant personal loans. After your lender reviews the property, you can get the funds. However, defaulting on your loan may be risky, especially when collateral is involved.
You can also use your mutual fund units to get a loan. You may pledge the mutual fund holdings with the NBFC or bank. The amount depends on the scheme and type of mutual fund. Notably, mutual funds' value changes over time.
So, lenders may reduce the LTV, or loan-to-value, on the loan against your mutual fund. Nonetheless, not all banks offer this type of loan. So, you need to visit the bank to understand whether it offers this type of loan before applying. Alternatively, you can check it out on the bank's official website.
In a land like India, where people celebrate gold as an asset and ritual of gift-giving, they can also use it as collateral. Truth be told, gold loans are secured collateral loans where you borrow money in return for your gold ornaments.
Banks and financial institutes offer a particular tenure. If you are unable to repay the due loan amount, they can extend the period. The prime benefit of using gold as collateral for loans is that it does not require any proof of income or credit assessment. Once you fail to repay it, the lender sells the account to recover the outstanding amount.
You can use your two-wheeler or four-wheeler vehicle as collateral while applying for a secured loan. In general, lenders can give a whopping 90% of the vehicle's on-road price as the loan amount. Your car will be kept as collateral in the bank during the loan tenure. Someone wishing to apply for the loan must show their monthly income.
You can apply for a mortgage loan by offering immovable assets. That might be your residential or commercial property as collateral. Your lender keeps your assets until you repay the amount. Take LAP or a loan against property, for instance. Such a type of loan can be classified as a mortgage loan. You may use this type of collateral loan to finance your child's wedding or education. Alternatively, you may initiate a business or cover medical expenses with a mortgage loan.
Collateral assignment of life insurance offers your lender collateral while you apply for the loan. The collateral is the face value of your life insurance policy. So, it can also be used to repay the amount if the applicant dies during the debt period.
So, the above are the prime types of collateral that borrowers usually use for loans.
Collateral loans offer clear benefits but also carry certain risks. You need to weigh both carefully before applying.
1. Reduced Interest Rate - Lower interest costs due to reduced lender risk.
2. Get Better Loan Amount - Access to larger loan amounts depending on asset value.
3. More Time for Repayment - Extended repayment options, making EMIs easier to manage.
4. Higher Approval - Higher approval chances compared to unsecured loans.
5. Long Tenure - Flexible terms & longer tenure availability.
1. Risk of loss - Risk of losing the pledged asset if repayments are missed.
2. Longer loan approval - Loan approval may take longer because of valuation steps.
3. Limitations with valuation - Sanctioned amount depends strictly on asset appraisal, which may be less than expected.
When it comes to secured loans in India, collateral is essential. It offers lenders security and allows borrowers to obtain higher loan amounts at affordable personal loan interest rates. Nonetheless, borrowers must manage their assets sensibly and know the dangers of pledging collateral.
So, do you want to apply for a secured loan while lowering associated risks? It's time to understand the following tips to ensure responsible borrowing and manage collateral accordingly. You can follow these tips to repay your loan carefully.
1. Assess How Much You Can Afford: Defaulting is the prime reason behind losing your valuable asset. So, you need to consider your repayment ability before pledging collateral. As a borrower, you must determine whether you can afford to pay the loan back in a timely manner.
2. Understand Your Loan Term: A borrower needs to understand loan terms before applying for the loan. You need to check the details of the interest rates and additional fees. Also, it is imperative to thoroughly check the conditions under which the lender can seize your collateral in case of default.
3. Never Overextend on Borrowing: A borrower should only borrow the minimum amount that you can repay within the agreed-upon terms. Overextending results in default, which further contributes to collateral loss.
4. Keep an Emergency Fund Aside: You cannot guarantee your future. In case of any unforeseen condition, you can use your emergency fund to cover the expense. So, whether it's a medical emergency or a financial issue, you can cover the expenses using your emergency fund.
Is collateral required for a personal loan? Secured loans are available through various lending channels. Each comes with its own terms & eligibility requirements. The options depend largely on the type of collateral being pledged.
1. Banks: The existing customers may receive funds quickly. At times, they receive the funds within the same day of application. Nonetheless, banks might impose restrictions on vehicle loans based on the model or mileage.
2. Credit unions: Membership is required but interest rates are lower than banks. Credit union APRs cannot exceed 18% by regulation. This makes them an affordable choice for many.
3. Online lenders: Many specialise in unsecured loans. However, some extend secured options. You might first need to apply for unsecured products before accessing the collateral loans.
4. Auto dealerships: Automakers offer financing through dealerships. These offers are usually competitive with bank or credit union rates. However, they demand strong credit for approval at best rates.
5. Pawn shops: Pawn loans deliver speedy access to cash without credit checks. Nonetheless, they are the costliest options. The short repayment period or higher interest rates make them a risky choice.
Collateral makes lending safer. You can default if you are a reliable borrower. This is in spite of having a strong credit history. Your lender secures the best interests by holding collateral. The pledged asset can be sold to reduce or cover the loss if a loan is not repaid.
Applying for a collateral loan involves a few clear steps that make the process easier:
1. Review your credit score: Check your credit score before submitting an application. A higher score improves your chances of approval and may help you secure better terms.
2. Compare loan offers: Explore secured loan options from different banks or financial institutions. Compare interest rates & fees to select the suitable offer.
3. Prepare required documents: Collect necessary paperwork in advance – such as identification & income proof alongside details of the collateral.
4. Submit the application: Give the completed application form alongside the pledged asset to the lender.
The approved amount is disbursed to your bank account once the lender verifies & processes your request. This may take only a few hours or a couple of days. Some banks release funds on the same day right after approval.
Recovering your collateral is straightforward once the loan is cleared. However, you should follow a few steps-
1. Repay in full: This is the first step to complete the loan repayment. You need to clear the the principal, interest, alongside other fees.
2. Lien release: The lender formally removes their claim. It usually involves official documentation in case of properties or vehicles.
3. Obtain proof: Obtaining the documents from the lender confirming the loan is paid is important. Collect confirmation from the lender that the loan is closed and the collateral is released.
Failing to clear a collateral loan has serious consequences for your credit standing & the asset you pledged. Missing payments can trigger two major outcomes:
The loan can slip into default after a grace period of around 30 to 90 days if you fall behind on payments. It is considered delinquent during this stage. Many lenders let borrowers discuss repayment plans before the loan officially defaults. However, continued delay worsens the situation.
2. You Risk Losing Your Asset
The lender has the right to take possession of the pledged collateral when the loan is unpaid. The timing of repossession depends on the lender as well as the type of loan alongside local rules.
Take the example of vehicles for example. It might be repossessed shortly after default. On the other hand, mortgage foreclosures usually begin 3-4 months upon missed payments.
So, do you wish to get a secured loan? It's time to check your credit score and repayment capabilities before using collateral for loan applications. Ensure that you borrow only as much as you can afford. The above things reduce your mental and financial strain and help you plan your finances effectively.
Not always. Property is only one type of collateral. Collateral is any asset pledged to secure a loan. This may include real estate or gold. Sometimes, it may be fixed deposits or vehicles. Property is the most common form. But collateral can be any asset acceptable to the lender as security.
An asset is anything valuable you own. Take the example of land or investments. Collateral is a type of asset pledged to a lender to secure a loan. Not all assets are collateral. They become collateral only when formally offered & accepted as security for repayment obligations.
Common examples include property, land, gold, vehicles, machinery, stocks, bonds, mutual funds, and fixed deposits. These assets are widely accepted by financial institutions because they hold resale value and can be liquidated if repayment fails. Collateral loans typically rely on stable, high-value assets that minimise the lender's credit risk.
Loans are divided into secured & unsecured categories. Secured loans require collateral (such as property or gold) to protect the lender. Unsecured loans are personal loans or credit cards. They do not need collateral but come with higher interest rates as the lender bears greater repayment risk.
Collateral is referred to by other terms such as security, pledge, guarantee or assurance. It may be called lien, hypothecation, or charge in legal & banking contexts. The terminology varies. However, all these words describe assets offered by a borrower to protect loan repayment.
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Unifinz Capital India Limited is a Non Banking Finance Company (NBFC) registered with the Reserve Bank of India (RBI). lendingplate is the brand name under which the company conducts its lending operations and specialises in meeting customer’s instant financial needs.
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