Do You Need Collateral for a Personal Loan?
Posted by Frank Gogol in Loans | Updated on May 30, 2023
A personal loan can be a good way to get money for important short-term needs. Numerous lenders in the U.S. offer personal loans. When choosing a lender, one important consideration to keep in mind is do you need collateral for a personal loan. Read on to learn more about this topic and decide if a secured personal loan is right for you.
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What is a Secured Loan?
A secured loan is backed by some kind of collateral. Collateral is something with monetary value that the lender can claim if you fail to repay the loan. By having collateral, the lender is theoretically guaranteed not to make a monetary loss. If they don’t receive the money you owe, they will receive the monetary value of your collateral.
Are There Secured Personal Loans?
Most personal loans are unsecured, meaning you do not have to provide collateral as part of the application process. However, some personal loan lenders do require you to provide some collateral for your personal loan. These are uncommon, however.
What is Collateral?
Collateral is anything with monetary value that you offer the lender as part of your loan application. If you fail to pay the loan back, the lender will claim your collateral to recover the money you did not repay. Collateral can take many different forms. A few common kinds of collateral assets are listed below.
Types of Collateral
Your lender will specify if they require you to provide collateral, and what form it can be in, but in general, the following assets are acceptable:
- Cash: Usually, this cash must be in a savings account, certificate of deposit (CD) account, or similar product.
- Car: You have to be the legal title holder of the vehicle, and usually, the car must be less than 5 to 7 years old unless it is a high-value classic.
- Boat: You must be the owner.
- Home: You must have some home equity if the house is not fully paid off.
- Investments: If you own stocks or bonds, you can use these assets at their spot value as collateral. Retirement investment products, such as a 401(k) account, are usually not eligible as collateral.
- Insurance policy: Certain types of insurance policies (e.g. life) can be used as collateral for a loan.
- Luxury items: Assets like fine art, jewelry, collectibles, and antiques can serve as collateral, but you will need to have their value professionally appraised.
- Precious metals: Metals like silver, gold, and platinum at their spot price can serve as collateral.
- Future income: If you can prove that your future income will be consistent (e.g. a paycheck), you can pledge it as collateral.
Pros and Cons of Collateral on a Personal Loan
Although you may be able to get a personal loan relatively easily if you provide collateral, there are some disadvantages to keep in mind. Below are some pros and cons to keep in mind when wondering do you need collateral for a personal loan.
Some advantages of a secured personal loan are:
- Easier: Lenders view loans as less risky if there is collateral (especially cash, stocks, and bonds), so the application process is often much easier. If your credit history is imperfect, you could qualify for loans that you would otherwise be rejected for.
- Bigger loan: Besides the process itself being easier, the lender may be willing to provide a larger loan if you can provide very valuable collateral.
- Lower interest: Collateral gives the lender confidence that they will not lose much money, even if you default. Thus, they are often willing to offer lower interest rates and longer repayment periods for secured loans.
- Better score: As with other types of loans, making consistent, on-time repayments on a secured personal loan improves your credit score over time.
Besides these advantages, it is important to also keep in mind the following risks of a secured personal loan:
- Loss: If you default on the loan (don’t repay it), the lender has the right to take away your collateral
- Collection: If your collateral does not cover the full value of what you owe, the lender may also send a debt collector after you to make you repay the balance. In some cases, if the amount is large enough, the lender may initiate legal proceedings against you to recover the money.
- Damage: The lender has the right to report missed payments to credit bureaus after 90 days. So missed payments or defaulting on the loan can seriously damage your credit score.
- Minimum: If you provide cash as collateral, the lender may impose a minimum balance on the account that the cash is in.
- Restricted: Some lenders may restrict how you can use your secured personal loan.
Considerations Before Signing a Loan Agreement
When wondering do you need collateral for a personal loan, you should pay attention to the following factors:
- Annual Percentage Rate (APR): Generally, the loan with the lowest APR is the least expensive, even if it isn’t the one with the lowest interest rate.
- Repayment period: This is the total length of time to pay off the loan. Shorter repayment terms often lead to higher monthly payments but potentially lower APRs.
- Discounts: You may be eligible for discounts if you have an existing relationship with the lender, or if you make special arrangements, such as automated loan repayment.
- Monthly payment: Although all other aspects may be ideal, the monthly payment determines whether, in practice, you will be able to make the payments for the loan along with your other expenses. Extending the repayment period can be one way to lower the monthly payment.
- Fees: Besides the fees included with interest in the APR calculation, some leaders charge other fees, such as prepayment penalties. These are fees for paying off the loan sooner than the full term. Be aware of these so you are not caught by surprise.
- Collateral: It is important to think about how it will affect your life if the worst happens and your collateral gets seized by the lender. For example, the consequences would generally be more serious if you lost your home than a valuable collection.
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When discussing the topic of do you need collateral for a personal loan, it is important to understand what is and isn’t collateral. Different lenders have different assets that they accept, but collateral in general is anything with monetary value that you offer in case you can’t repay a loan. There are many benefits of a secured personal loan, including a higher loan amount and potentially lower interest rates. However, it is important to consider the total cost of the loan and how your life could be affected if your collateral is seized.