What Is Collateral and How Does It Work?

A personal loan can be useful in helping you accomplish a number of goals — consolidating debt, financing home improvements, making large purchases or covering unexpected expenses. As you’re looking into loan options, you may be offered one that requires the borrower to put up collateral for the loan. If you’re unsure what is considered collateral or how collateral works on a loan, this breakdown can help you determine whether a collateral loan is right for you.

What is a collateral loan?

Most personal loans are offered as either secured or unsecured loans. Secured loans are also referred to as collateral loans, because they require that you offer something of value that you own — like a vehicle or property — in the event that you default on your loan. Borrowers typically have a better chance of getting approved for a secured loan, because the collateral protects the lender against losing money. Loans that don’t require collateral are called unsecured loans.

Why do some loans require collateral?

Most financial institutions, including national banks, community banks, credit unions and online lenders, offer collateral loans or secured loans. When lenders are deciding whether to offer you a loan, they look for factors that determine if you’re creditworthy, like your credit score, monthly income, debt-to-income ratio and payment history. If the lender believes that you may have trouble paying back a loan, they may ask you to offer something as collateral to reduce their risk.

If you do not repay the secured loan according to the terms of the loan agreement, the lender has the legal right to take possession of the asset that was pledged as collateral and sell it to make up for the money they've lost.

Common examples of collateral

What is considered collateral varies from lender to lender. Common examples of collateral include:

• Motor vehicles — If your car is paid off and meets the lender’s requirements, you can use it as backing for your loan.
• Savings — A savings account can sometimes be used as collateral for personal loans. In the event of default, the lender can take the funds as compensation. In this sort of arrangement, the savings will often need to be secured in a CD (certificate of deposit) account. The borrower will not have access to the funds until the loan is paid off.
• Paychecks — This is when a loan is secured using the borrower’s actual income. In the event that the borrower defaults on the loan, they will be subject to wage garnishments.
• Personal goods — Some lenders allow valuable property to be used to back a loan, including jewelry, fine art or collector’s items.

It is important to note that not all lenders accept the same items as collateral. You should always check with a lender first to find out what is considered collateral before applying for a loan.

What are the benefits of using collateral?

Securing a personal loan with collateral could give you more options, especially if you have a fair or poor credit score. Using collateral can improve your odds of getting a loan, could qualify you for a larger loan amount and could result in a lower interest rate, since this kind of loan is by nature less risky for the lender than an unsecured one.

Of course, you must always keep in mind: If you do not pay back the loan, you may lose the item offered as collateral. But if you are diligent about making payments on time, using your assets or property to secure a loan can be a responsible option.

What are collateral loan rates?

A secured or collateral loan may have a lower interest rate than an unsecured loan, but keep in mind that loan rates and terms will vary based on personal information like credit history, income, expenses, debts and available collateral.

What does OneMain Financial use as collateral?

If you’re applying for a personal loan with OneMain, your loan specialist may offer you the option of a OneMain Financial secured loan, which will require collateral. They will explain the OneMain Financial vehicle collateral requirements as well as other collateral options that may be available to secure your loan.

Is using collateral right for you?

Everyone’s financial situation and needs are different. If you have items of value or cash in the bank to offer as collateral — and you’re certain you can make your loan payments on time — a collateral loan can be a useful way to get access to the money you need to accomplish your financial goals.

This article was originally published on May 1, 2019. Joe Guida and Matt Diehl contributed to this article.