Collateral is an asset with real monetary value held by a borrower that can be seized by a lender if the borrower can no longer make payments.
If a lender is not fully confident that a borrower will repay them, that lender may require the borrower to provide security before issuing the loan.
Collateral helps lenders reduce risk. Lenders may want to hold an asset as collateral so they can seize and sell it to cover some of their losses.
Depending on your creditworthiness, a lender might not want to lend you money without collateral for fear that you will pay off your debt. This concern could stem from a problem with your credit score or a lack of credit history.
Alternatively, a lender may still choose to lend you the funds you need for your purchase, but at a higher interest rate than you want or can afford. By securing a loan with collateral, a borrower can potentially unlock a lower interest rate or better repayment terms. A lender may be more willing to lend you more money if you post collateral.
The type of asset used as collateral is generally relevant to the intent of the loan. For instance:
- A car loan can use the purchased vehicle or another vehicle you own as collateral.
- A mortgage or home equity loan can use purchased property as collateral.
- A secured credit card can use a prepaid cash deposit equal to the card’s credit limit as collateral.
- The issuer of a passbook loan, which is essentially a cash loan, uses your bank savings account as collateral.
- The issuer of a small business loan can ask for collateral in the form of product inventory, accounts receivable, equipment, intellectual property or real estate.
- A payday lender issuing short-term debt could use your future paychecks as collateral.
But lenders will accept a variety of assets to use as collateral, including:
- Investment accounts (but not retirement accounts), bonds, stocks, certificates of deposit, insurance policies, and digital assets such as cryptocurrencies or non-fungible tokens.
- Boats, vacation homes, land or rental properties.
- Valuable assets such as art, antiques, jewelry, precious metals, and rare or expensive collectibles.
Regardless of the type of loan, the asset you intend to use as collateral must meet a few benchmarks. To begin with, it must be a desirable element; no bank will want to accept a rusty old car as collateral, but they will probably consider a brand new convertible or a classic sports car that has been properly maintained.
The item must be resalable and transferable. Maybe you have a massively heavy but valuable antique gold statue in the backyard. If it costs more to market, sell, and transport the item to a new buyer than it is worth, a financial institution is unlikely to be inclined to use it as collateral because of the cost of liquidation.
Any potential and significant fluctuation in the value of the asset would also be taken into account in determining whether the financial institution accepts it as collateral. A non-fungible token, for example, may have been purchased for $100,000, but a financial institution would need to assess whether reselling that NFT would yield at least $100,000.
Once you have successfully repaid the loan, the lien is removed by the lender, who no longer has any legal rights to the asset.
No. Although you may become a more attractive borrower, your collateral may not be of sufficient value to outweigh other considerations that would make lending you money a bad business decision. Banks and other lenders have loan management and underwriting tools and practices to determine if you are creditworthy.
A fixed charge is a lien applied to a specific asset held by the borrower. A floating charge is a lien applied to an asset held by the borrower that has a variable value, such as stocks or accounts receivable.
Secured credit is when a loan is secured by collateral. Unsecured credit means that there is no collateral pledged if payments are not made.
Yes. Liens are noted in the public folder, so anyone can find out if there is a lien placed on your property or accounts.