What is Collateral?

If you’re looking to get a loan so that you can purchase your dream home or start your own business, you may be asked to put up collateral. Collateral is a way of protecting lenders that can also help you get better rates, but using it to secure a loan can spell trouble if you fail to repay.

What is collateral?

Investopedia Senior Editor Julia Kagan defines collateral as an asset that is accepted by lenders as security for a loan. Whereas some loans, called unsecured loans, won’t ask for collateral, a secured loan requires that you put up some type of property or asset to protect the interests of the lender.

Mortgage and auto loans typically require some form of collateral since the amount borrowed is higher. In practical terms, if you fail to make payments or default on your loan, the lender can legally seize your collateral in place of payment. This involves the borrower taking out a lien on your property.

If your assets don’t satisfy the total amount owed, Kagan writes that the lender can take you to court for the remaining balance. In its glossary entry for collateral, Bankrate notes that this comes down to whether or not the loan is a recourse loan, which legally permits the lender to pursue additional assets until they are made whole. 

Is collateral required for business loans?

Dale Van Eckhout, a senior area manager for the Small Business Administration, writes that collateral is also commonly required for some business loans. He notes that lenders do not want to see businesses or individuals fail — they simply require collateral to protect themselves and show that borrowers have “skin in the game.”

Having “skin in the game,” as Van Eckhout puts it, is only something to be concerned about if you aren’t able to pay your loan back. If you make your payments on time and pay back the full amount, you’ll never even remember that your assets and property were in the balance.

Are there advantages to putting up collateral?

Using collateral can have a positive impact over the lifetime of your loan. Credit Karma contributor Melanie Lockert notes that providing collateral as security for a loan means that you are less of a risky investment for lenders. That means you can potentially ensure a lower annual percentage rate, which helps you save more money over the lifetime of the loan. You may also be able to borrow a larger sum than you would without collateral.

While unforeseen and unfortunate circumstances can and do occur, you should always go into taking out a loan with the mindset that you will make your payments on time and repay the full amount. If you have the utmost confidence that you will, taking out a secured loan is a great way to make your money stretch further.

What can be used as collateral?

While your lender may have limitations on what they’ll accept as collateral, most financial institutions accept some common assets and property. Experian contributor John Egan lists common collateral options including your home, car, savings, and certificates of deposit.

Other options for securing personal loans might include collectibles, antiques, fine art, and jewelry. Because these assets are a bit more nebulous, Jamie Johnson, a personal finance writer for The Balance, notes that you’ll need a professional appraisal to determine the collateral value. You may also want to have your home and vehicle reappraised to get the most accurate value before putting it up as collateral.

When securing a business loan, Van Eckhout suggests that real estate, office and manufacturing equipment, inventory, and accounts receivable can all be used as collateral. You can also put up personal property as collateral for a secured business loan, but taking out a second mortgage on your home to fund your business venture is a significant risk that should be considered at length.

Using collateral to secure a loan is not at all uncommon, and it’s not anything to worry about unless you find yourself unable to make payments. Before obtaining a loan, be sure to shop around for different options and seek the advice of a financial professional.