How Does A Collateral Loan Work?
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Often a lender will ask you to put down collateral when you go to apply for a business loan. This is because in getting that collateral, they now have something with which to secure the loan. This means if you cannot repay the money and you do ultimately default, they at least have assets on hand to try and recoup their loss. Collateral can take a multitude of forms, from real estate to equipment to vehicles. In this article, we take a closer look at how these types of loans work.
What is a Collateral Loan?
Sometimes called a secured loan, a collateral loan is one that has some form of guarantee. In other words, you are putting down something of value, some assets to secure the loan. If you default, the lender can then seize these proposed assets and sell them to try and get the money owed back. Again, some common forms of collateral are real estate, equipment, inventory; even things such as art and jewelry depending on their value can be pledged.
Because you are offering security on the loan by way of collateral, you will generally find that collateral loans do tend to have lower interest rates. Again, this is attributed to the fact that a lender has less risk because they have the collateral in case of nonpayment. For borrowers who have low credit scores or who haven't been in business for that long, a collateral loan might be their only option as they probably would not be approved for an unsecured loan.
Understanding How a Collateral Loan Works
The terms associated with a collateral loan are generally more favorable as the loan is secured by your pledged assets. So for example, the interest rate might be lower, there could also be a longer repayment period, and even the loan amount itself could potentially be larger than you'd otherwise have with an unsecured loan.
In approving you for a collateral loan, one of the things a lender must do is to determine the value of the collateral you are putting up. In some instances, where real estate is involved, for example, they will have to get an appraisal of the property and then from there figure out its fair market value. In coming up with the loan amount, the lender will offer a percentage of what the collateral's total value is. This value is reflected in the LTV (loan-to-value/) ratio associated with the loan. The higher the LTV, generally the more interest you will pay. Additionally, depending on loan terms you may need a bigger down payment as well.
Where to Get a Collateral Loan
You can apply through a traditional bank; especially if there's one with which you already have accounts in good standing, this could be a feasible option. Bank loans however can take a bit of time as the application process is not as fast as you'd get with an online lender for example. Online lenders are another great resource for collateral loans. And with many such lenders, they can get you the funds rather quickly;, in certain circumstances, it could be a matter of a couple of days.
A mortgage is also another form of a collateral loan. With residential mortgages, the property itself becomes the collateral. So if you fail to pay, the lender can then foreclose on the home. Auto loans work in much the same way. The car itself stands as the collateral. And again, if you stop paying the loan, the bank or lender will repossess the vehicle and then try and sell it to get some of their money back.
Applying for a Collateral Loan
As with any type of loan, the lender is going to focus on certain components of your application to determine whether or not you qualify.
- Credit score. A credit score will often factor into a collateral loan. Even though there is some asset(s/) securing the loan, lenders do tend to evaluate creditworthiness via your FICO. So know where your score stands and address any errors or inaccuracies.
- Talk to a few lenders. Loan terms and rates are going to vary from lender to lender. Also, you want to give yourself the best shot at approval; some lenders are more stringent than others on collateral loan qualifications. So you may need to do a little homework here.
- Once you choose your lender you need to put together your loan application packet. The lender will ask for the application itself along with supporting documents, things such as financial statements, tax returns, among other information. They will also carefully evaluate the collateral you're pledging to secure the loan.
- Upon being approved for the loan, you then simply wait to receive the funds within your account.
What if You Default on the Loan?
When you are in default on a collateral loan you could be in danger of losing the assets you put up. If you are late thirty days, there may be a grace period during which you can then make up that payment and thus keep your assets. However, if you're habitually delinquent and go beyond the allotted grace period, then you do run the risk of losing the collateral backing the loan. If you foresee issues, it is so important to talk with the lender; be honest about your situation and see if there isn't some sort of action/plan that can be put in place before the loan does go into default.
One thing you want to be sure to do is to understand exactly what can occur with a default. Review all terms and conditions thoroughly. Know what you're getting into before accepting any sort of loan. You might also want to do some research in terms of your state's laws regarding seizing property on account of nonpayment of a loan.