Assets such as houses, automobiles and stocks can be placed as collateral to secure a loan.
Collateral loans, also known as secured loans, have both advantages and disadvantages. Some advantages of taking out a collateral loan are that it is usually easily and quickly approved, and the borrower can usually borrow more money than they would with an unsecured loan. When taking out such a loan, however, the property used as collateral is at risk if the borrower cannot fully repay the loan within the given time frame. Another con of collateral loans is that they are not available to just anyone. If the potential borrower does not have a home, vehicle or other piece of property routinely used as collateral, he or she cannot take out a loan as collateral.
Lenders often approve collateral loans even if the borrower does not have a good credit history.
Due to the nature of collateral loans, the risk to the lender is small. If a debtor is unable or refuses to repay the borrowed amount, the creditor is essentially the owner of the debtor’s property. With that in mind, lenders are often quick to approve loans even if the borrower does not have an impeccable credit history. Most of the time, people who are rejected for unsecured loans can get a secured loan because there is much less risk for the lender. While this is a definite advantage over unsecured loans, it is up to the borrower to determine whether it is worth taking the risk of borrowing collateral.
Depending on wealth and affordability, people using collateral loans can usually borrow large sums of money, while unsecured loans have a much lower limit. With unsecured loans, the lender assesses the potential borrower’s income and limits the loan amount before the risk is too high. Collateral loans do not present this problem because the lender can claim ownership of the borrower’s property if he or she fails to pay. Therefore, lenders are often more willing to lend large amounts of money if the borrower’s property can be sold to repay the loan.
One of the drawbacks of taking out this type of loan is the risk of losing the property. If the borrower becomes ill or faces a professional crisis, he may be late in repaying the loan. While lenders are sometimes willing to go without payment for several months during an unforeseen emergency, in the end the borrower is expected to make regular payments again. If he fails to do so, the lender may try to take the borrower’s property.
Another disadvantage of collateral loans is that they are only available to people who own property. For the significant percentage of people who rent homes or cars, collateral loans are basically useless because there are no collateral to offer. Often, these people are forced to seek out unsecured loans, which are usually only available to people with a good credit history.