By John EganWhat Can Be Used as Collateral for a Personal Loan?
By John Egan
When you take out a personal loan, you may have a secured or unsecured loan. With a secured loan, you must pledge something valuable, called collateral, to back the loan in case you default.
Read along to learn about collateral, including the types of collateral you can use for a personal loan and the pros and cons of using collateral.
What Is Collateral?
Collateral is something of value that you own, like a car or a savings account, that you offer to secure a personal loan. If you don't repay the loan, the lender can take ownership of the collateral to cover the amount you still owe. Collateral minimizes a lender's risk in providing a personal loan.
Keep in mind that the value of the collateral must be comparable to the amount of the loan. So, if you take out a $25,000 personal loan, a car worth $10,000 might not be sufficient collateral.
Furthermore, if you owe money to a lender on something you offer as collateral, a lender might frown on that collateral because you don't technically own it.
Do All Personal Loans Require Collateral?
Most personal loans do not require collateral. These are known as unsecured loans. In the case of an unsecured loan, you promise to pay back the loan and interest within a certain period.
The other type of personal loan, a secured loan, does require collateral. The collateral offered for a personal loan represents your promise to pay off the loan. Because a secured loan has collateral, a lender might give you a bigger loan with a lower interest rate because the lender's risk is reduced.
Learn more: Secured vs. Unsecured Personal Loans: What's the Difference?
Types of Collateral You Can Use for a Personal Loan
You can typically use almost anything of value that you own as collateral, including:
- Cars
- Boats
- RVs
- Motorcycles
- Homes
- Jewelry
- Fine art
- Antiques
- Stocks, bonds and certificates of deposit (CDs)
- Insurance policies
- Non-retirement savings and investment accounts
- Cash
- Precious metals like gold
- Equipment and machinery
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Pros and Cons of Collateral for a Personal Loan
Using collateral for a personal loan does come with pros and cons, such as potentially lower interest rates and the possibility of losing your collateral.
Pros
-
Credit flexibility: Most lenders don't insist that a borrower have good credit.
-
Attractive interest rates: Lenders typically offer lower interest rates on secured personal loans.
-
Potentially larger loan: Based on the value of your collateral, you may be able to get a larger loan than you could with an unsecured loan.
Cons
-
Ownership risk: If you fail to pay off the loan, the bank might seize your collateral.
-
Longer application process: It may take more time to qualify for a secured loan than it does other kinds of loans, as your collateral's value must be assessed.
-
Requires ownership: You must own your collateral free and clear to offer it up as collateral, so a car with a loan still attached won't be accepted, for example.
What to Know Before You Sign a Personal Loan Agreement
Before you sign a personal loan agreement, answer these questions:
- What is the annual percentage rate (APR)?
- How much time do you have to pay off the loan?
- How much are the monthly payments?
- What is the monthly due date?
- What sorts of fees could I be charged?
- Is there a penalty for paying off the loan early?
- Will I be required to sign up for autopay?
- Are there limits on how I can spend the borrowed money?
- What happens if I miss a payment?
- What happens if I don't pay back the loan?
- How will legal disputes between me and the lender be resolved?
These will help you determine if the loan is right for your needs and your budget and, if you're shopping around with multiple lenders, could be easy points of comparison.
Alternatives to Using Collateral for a Personal Loan
Fortunately, you have options if you don't want to or can't use collateral for a personal loan. They include:
- Getting an unsecured loan: An unsecured loan doesn't require collateral. If your credit isn't in the best shape, take some time to improve it so you can qualify for an unsecured loan.
- Asking your family: Consider borrowing money from relatives or friends. Because this could put a strain on your relationship, make sure you have a clear plan—in writing—for repayment.
- Using a cash advance: If you need a smaller amount of money, you could use a credit card to obtain a cash advance. Just remember that a cash advance may come with a hefty APR or upfront fees, and likely will start accruing interest right away.
- Looking into a personal line of credit: A personal line of credit allows you to borrow based on your credit, leaving collateral out of the mix. You will likely need good or excellent credit to qualify, though.
- Going the peer-to-peer route: Peer-to-peer lending platforms lend money from investors seeking to profit from interest charges. These may be a great option if you are struggling to borrow money through traditional means, like a personal loan or line of credit.
- Considering a 401(k) loan: If you have a 401(k) retirement plan through your employer, you may be able to borrow money from it. Just be aware that there are limits on your loan, you'll have to repay it in under five years and you'll miss out on returns on the portion of your 401(k) you borrowed while you pay the loan back.
- Borrowing from your home's equity: A home equity line of credit (HELOC), home equity loan or a cash-out refinance loan might be the way to go. But do be careful, as ownership of your home could be jeopardized if you default on one of these options.
- Borrowing from a life insurance policy: If you have life insurance, you may be able to borrow money against it if the policy has a cash value. In this case, only a permanent life insurance policy would qualify, though.
Frequently Asked Questions
The Bottom Line
Collateral is a valuable asset—such as a car, home, savings account or investment portfolio—that a borrower pledges to secure a personal loan, giving the lender the right to seize it if the loan isn't repaid. While most personal loans are unsecured and don't require collateral, secured loans can offer advantages like easier qualification, lower interest rates and larger loan amounts, although they carry the risk of losing your asset and typically involve a longer application process.
If you're considering a personal loan, check your credit report and FICO® ScoreΘ for free from Experian to see where you stand. You'll also get recommendations of moves you can make to improve your credit for future borrowing.
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About the author
John Egan
John Egan is a freelance writer, editor and content marketing strategist in Austin, Texas. His work has been published by outlets such as CreditCards.com, Bankrate, Credit Karma, LendingTree, PolicyGenius, HuffPost, National Real Estate Investor and Urban Land.
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