What Are Collateral Loans and How Do They Work?
A collateral loan is a form of debt secured by a valuable asset. You risk losing that asset — your car or home, in some cases — if you can’t repay your loan, so weigh your options carefully before securing a personal loan with collateral.
What is a collateral loan?
A collateral loan — also called a secured loan — is backed by something you own. The item that backs the loan is called collateral. The lender has the right to seize the collateral if you can’t repay the loan.
Collateral loans often come with lower interest rates or larger loan amounts. They may be the only option for low-income borrowers or people with bad or limited credit.
Unsecured loans, on the other hand, are typically backed only by your promise to repay. Your eligibility and rates are based on the lender’s confidence in your income and credit history.
What is collateral for a loan?
Some of the most common types of collateral are cars (auto loans) and houses (mortgages). Other forms of loan collateral include:
- Savings account/certificate of deposit (CD)
- Boat
- RV
- Piece of jewelry
- Investment portfolio
- Real estate
- Insurance policy
Pros and cons of collateral loans
If you have bad credit or little credit experience at all, you may be able to qualify for an affordable loan by putting up collateral. But before agreeing to take on a collateralized loan, it’s smart to make sure that the benefits outweigh the risk of losing your asset.
| Pros | Cons |
|---|---|
| Help borrowers with below-average credit scores access financing May offer lower interest rates and larger loan amounts than unsecured loans Help borrowers build credit and improve their scores | Loan eligibility limited to borrowers with valuable assets Additional red tape during the application process Risk losing your asset |
How do collateral loans work?
Before a lender approves you for a collateral loan, it’ll need to determine how much your collateral is worth by assessing its fair market value. In the case of a mortgage, this is called a home appraisal.
The size of your loan will be determined as a percentage of your collateral’s value.
In a mortgage, the value of your collateral is directly reflected in the loan-to-value (LTV) ratio the lender assigns to your loan. In general, the higher your LTV ratio, the more you can expect to pay in interest and closing costs. You’ll also need a larger down payment. For example, if your LTV ratio is 80%, you’ll need to provide the remaining 20% out of pocket.
Where can you find loans with collateral?
If you’re ready to compare secured loans from top lenders, keep in mind that some lenders and financial institutions limit what assets they accept. Your options will depend on the collateral you have to offer.
- Banks: If you already have an account with a bank, you may be able to get bank loan funds on the same day you apply or the next business day. Watch for potential restrictions on car loans, however. Banks often restrict loans based on make, model, mileage or year.
- Credit unions: You’ll likely need to be a member of the credit union to qualify, but credit union loan rates are typically lower than bank rates. Annual percentage rates (APRs) for credit unions are capped at 18% by the National Credit Union Administration.
- Online lenders: Many online lenders only offer unsecured loans, and you may have to apply for an unsecured loan before you see a secured loan option.
- Auto dealerships: Automakers typically offer car financing through their dealerships. Manufacturer financing rates are often competitive with those offered by banks and credit unions, but you’ll need strong credit to qualify for the best rate.
- Pawn shop loans: These short-term loans don’t require a credit check and provide nearly instant access to cash. Avoid pawn shop loans whenever possible — they often come with sky-high interest rates and short repayment terms.
Types of collateral loans
There are many types of collateral loans. Here are some of the most common:
Mortgage
With a traditional mortgage, your house is the required collateral. If you default, you risk losing your home through foreclosure, which means you’ll no longer own the property.
Home equity loan
As with a mortgage, your home serves as the collateral for a home equity loan. You’ll draw against the equity — or ownership — you’ve built up in your home and receive a lump sum that can be used for a variety of things, including home renovations. A home equity loan comes with a fixed interest rate, but you’ll need to keep up with your monthly payments to avoid damaging your credit or losing your home.
Auto loan
Auto loans are secured by the vehicle you plan to buy. While there are unsecured car loans out there, the majority of borrowers choose secured auto loans because they offer the best interest rates.
If you default on your loan, your lender may repossess your car. That said, some lenders may be willing to defer payments or offer loan modification to avoid repossession because cars lose value quickly.
Car title loan
If you need to borrow a small amount of money for a short period of time, you can use your car title as collateral for a loan. However, it’s best to avoid car title loans since they typically have to be repaid within 30 days, come with fees and carry high interest rates. If you miss payments, the lender can seize your car.
Personal loan
A secured personal loan can be used for almost any purpose, like fixing a home or consolidating debt. You may be able to use a personal savings account or CD as collateral for a secured personal loan. But if you default, you risk losing those assets.
How do you apply for a collateral loan?
You can apply for collateral loans one by one on lender websites, or you can save time shopping around by applying with LendingTree. Here are the steps to apply for a loan with us:
- Fill out a form. When you complete a single loan application with LendingTree, you’ll receive up to five loan offers from our network of more than 300 lenders.
- Compare offers and choose a lender. Review your loan offers, comparing interest rates, fees and terms to make sure you’re choosing the best offer.
- Receive your money. Once you’ve submitted your final loan application and any required documentation, you’ll get your loan funds. Note that some secured loans, like mortgages, can take up to 60 days to close before you receive your money.
What are collateral loan rates?
Collateral loan rates depend on the type of loan and the collateral you have to offer. Typically, the more valuable your collateral, the lower the rates. We’ve compiled typical rates as of July 2024.
| Loan type | Collateral | Typical rates |
|---|---|---|
| Mortgage | Home | Averaging 6.94% APR for 30-year fixed mortgages |
| Home equity loan | Home | Starting at 6.88% APR |
| Car loan | Vehicle | Starting at 4.09% APR |
| Car title loan | Vehicle | 300% APR |
| Personal loan | Savings account or other collateral | Up to 36% APR |
What happens if you don’t repay your debt?
Failing to repay a collateral loan has consequences for your credit and for the ownership of your asset. The two major repercussions of missing collateral loan payments are:
Your loan will go into default
If you miss payments, your collateral loan will eventually go into default. Most lenders offer a grace period of 30 to 90 days. Your loan will be delinquent during that time, but you may be able to work with your lender to come up with an acceptable payment plan before your loan actually goes into default.
You’ll lose your collateral
If your account continues to be delinquent, you risk losing your asset. The exact timeline of repossession depends on the lender, the type of loan and your state of residence.
For example, your lender might be able to repossess your car as soon as your loan goes into default, which is often when you miss a payment.
If you’ve defaulted on your mortgage, the foreclosure process will usually begin three to six months after you first miss a payment, although in some states, lenders may have to take you to court first.