What Is Collateral?
Summary
Collateral for a loan is an asset you pledge, like a car or property, that a lender can claim if you can’t repay. Learn how it works and how it can help you reach your goals.
In this article:
A personal loan can help you accomplish a variety of goals, from consolidating debt to financing home improvements. When exploring personal loan options, you may come across two main types: secured loans and unsecured loans.
A secured loan requires you to provide something valuable, called collateral, to back the loan. This could be a car, truck or even a boat. Collateral gives the lender a way to recover their money if you can’t repay it.
Alternatively, an unsecured loan doesn’t require any collateral, but it may come with a higher interest rate because it’s riskier for the lender.
If you’re considering a loan that requires collateral, understanding how it works can help you make informed decisions about your financial needs.
How collateral works
Collateral is something valuable, like a car or truck, that you offer to a lender as security for your loan. Unlike unsecured loans, which don’t require collateral, secured loans use collateral as a promise that you’ll repay what you borrow. If a borrower fails to repay the loan, the lender has the right to take possession of the collateral to recover the amount owed.
Common examples of collateral
What you can use as collateral varies from lender to lender and depends on the type of loan. Common types of collateral include:
- Motor vehicles — If you have a car, RV or motorcycle that meets the lender’s requirements, you could use it to back a secured loan. You can also use your vehicle to secure an auto loan or title loan. Keep in mind that there are eligibility requirements such as the condition and age of your vehicle and proof of insurance.
- Home — If you purchase a home or apply for a home equity loan or home equity line of credit (HELOC), the property is considered the collateral for the loan. If you default on your loan, the lender has the right to foreclose your home to collect what you owe.
- Personal goods — Some lenders allow you to use valuable property to back a loan, including fixtures in your home, 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 types of collateral are eligible before considering a secured loan.
What types of loans require collateral?
Here are some common types of secured loans:
- Mortgage — A loan used to purchase a home; the property itself serves as collateral.
- Home equity loan — A loan that uses the equity in your home as collateral. Equity is the value of your home, minus what you still owe.
- Secured personal loan — A loan that requires you to pledge an asset like a savings account, vehicle or other valuable property as collateral.
- Auto loan — A loan used to finance a vehicle purchase; the car you’re buying serves as collateral.
- Car title loan — A short-term, high-interest loan that uses your car title as collateral.
Why do some loans require collateral?
When lenders decide whether to offer you a loan, they look for factors that determine your creditworthiness, like your credit score, income, debt-to-income ratio and payment history. If you're not approved for an unsecured loan, the lender may offer you a secured loan, which is a lower risk to them because you are offering collateral to back the loan. Collateral can improve your chances of getting approved for a loan, even if your credit is less than perfect. If you can't pay back the loan, the lender reserves the right to take and sell the collateral to recover their money.
What are the pros of using collateral?
- More options available: Securing a loan with collateral could give you more options, especially if you have less-than-perfect credit.
- Easier approval: Using collateral could help improve your odds of getting approved for a loan.
- Higher loan amount: A secured loan can qualify you for a larger loan amount based on the value of the collateral you provide.
- Lower interest rate: Some lenders may offer a lower interest rate on a secured loan compared to an unsecured loan.
What are the cons of using collateral?
- Risk of losing the asset: If you fail to repay the loan, you may lose the asset you are using as collateral.
- Extra time: Backing a loan with collateral can also require time for you to verify your ownership of the collateral and for the lender to assess the value of the collateral.
- Restrictions on collateral: While the loan is active, you might have restrictions on selling or transferring the collateral until you’ve paid back the loan. You’ll also need to make sure you have insurance coverage to protect the collateral you used to back the loan.
Is using collateral right for you?
Everyone’s financial situation and needs are different. If you have something valuable, like a car, to offer as collateral — and you know you can make your loan payments on time — a secured loan could be your best option for getting approved for the money you need to reach your goals. Equipped with solid information about collateral loans, you can make smart decisions for your financial health.
This article had previous postings from 2019-2023. Joe Guida, Matt Diehl, and Kim Gallagher contributed to this article.
This article is for general education and informational purposes, without any express or implied warranty of any kind, including warranties of accuracy, completeness, or fitness for any purpose and is not intended to be and does not constitute financial, legal, tax, or any other advice. Parties (other than sponsored partners of OneMain Financial (OMF)) referenced in the article are not sponsors of, do not endorse, and are not otherwise affiliated with OMF.
