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What Are Collateralized Personal Loans & How Do They Work?

What Are Collateralized Personal Loans?
Sheryl Nance-Nash

Sheryl Nance-Nash

Updated January 12, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
A collateralized personal loan, also known as a secured personal loan, is one that is backed by an asset, such as a car or a house. If the borrower were to fail to repay a personal loan with collateral, the lender could seize that asset. Though there is that risk, the upside is that collateralized loans may have lower interest rates and be easier to get because there is collateral backing the loan.Read on for a more in-depth collateralized loans definition and some tips on how to get a personal loan with collateral.

Collateralized Loans Definition

With a collateralized loan, you agree that if you fail to repay the loan according to the contract, the lender has the right to take the property that’s securing the loan, which is known as the collateral. This differs from an unsecured personal loan, in which the lender only relies on your credit history to determine your likelihood of repaying the loan. In a personal loan with collateral, the lender will typically put a lien against the property that’s being used to back the loan. The lien is what gives the lender the legal right to take your property if you fail to pay back what you owe.And even though you’ve put up your property — perhaps your home or car, for example — that doesn’t mean you can’t use it while you’re paying off the loan. There will simply be a lien on it until you pay off the loan and the lender removes the lien on your asset.

Pros and Cons of Collateralized Personal Loans

For sure, it’s no small matter to face the possibility that if for some reason you can’t make good on paying back the lender, you risk losing something of significant value. Only you can decide whether it’s worth doing.

The Pros

There are advantages to collateralized personal loans, largely because the lender has the safety net of your collateral. Specifically, the pros of a collateralized personal loan may include:
  • The lender may offer a larger loan amount.
  • The interest rates may be lower than with an unsecured loan.
  • You may qualify for a loan even if your credit scores aren’t stellar.
  • For those with little credit, a secured loan can be a way to build credit.

The Cons

Of course, there are downsides to getting a collateralized loan to consider as well:
  • Depending on your situation, a job loss, an unexpected illness or other unforeseen circumstances could cripple your finances. It’s a good idea to make sure you have sufficient savings — enough to make those loan payments — to tide you over should such a crisis occur so you don’t end up losing your collateral.
  • Because an asset is involved, that means more paperwork. You’ll need all the documentation that shows you are the owner of the asset, and the lender will need to verify that information. This means this process won’t be as quick as perhaps applying for an unsecured loan when less is on the line, marking another difference between unsecured and secured loans.

What Qualifies as Collateral for Personal Loans?

A number of assets may be accepted as collateral for a personal loan, such as real estate, vehicles and other investments.

Real Estate 

You can use your home or home equity as collateral for a loan. As this is likely your biggest asset, consider if this should be your first choice. It may not be, unless you are as close as humanly possible to being 100% certain that you can pay back the loan.If you're considering borrowing against your home equity, you might also consider the differences between personal vs. home equity loans to see what may be better for your situation.

Vehicles

Your ride can do more than get you from Point A to Point B — you also can use your car as collateral for a secured personal loan. The loan is secured by the vehicle’s value, which is usually taken from what’s estimated in the Kelley Blue BookAgain, if you don’t hold up your end of the deal, you could lose your car. Know too, that if your car is a clunker, it’s not likely to dazzle a lender into offering you a loan. Ask the lender about requirements. Also keep in mind that you won’t be able to sell your car while it is being used as collateral.

Other Investments

If you’re understandably nervous about putting your home or car on the line, you have other options, including stocks, bonds, antiques, cash in a savings account, certificates of deposit, jewelry or collectibles, for example.  Look through your assets to see where you might get what you need and for the least amount of pain if things go south and you can’t pay back the lender.

Alternatives to Collateralized Personal Loans 

After thinking things through, it’s possible that the answer to the question of ‘should you get a personal loan with collateral?’ is no. There are alternatives, including:
  • An unsecured personal loan: Among the different kinds of personal loans, another option to explore is an unsecured personal loan. This might be a good option if you have a high credit score, as you may qualify for a better interest rate because you’re considered less of a risk. Typically, interest rates can be higher for unsecured personal loans as there is no collateral backing you.
  • Borrowing from family or friends: You might turn to family and friends to get the funds you need. Just keep in mind that if you fail to repay the amount borrowed in a timely manner, your relationship with that person might be on the line.
  • A secured credit card: If you’re looking for a way to boost your credit score but have too thin of a credit history to qualify for much, a secured credit card could be an answer. With a secured credit card, you put down a deposit that’s typically equal in amount to your credit line. The issuer can hold the deposit if you don’t pay your bill

Collateralized Personal Loan Application Process: What to Expect & Tips for Success

If you’re ready to pursue a collateralized personal loan, keep in mind the following tips:
  • Take the time to get your documentation in order before applying. For starters, you’ll need proof that you own the asset. Also expect to be asked about your credit history and credit score. The lender will also likely request to see bank statements and proof of income.
  • Be prepared to shop around. Like all financial products, each lender has their own requirements and pluses and minuses. Examine them closely, and consider various options, from banks to credit unions to online lenders.
  • Review your credit report yourself before applying: If you want to up the odds that you get approved for the loan, even before you approach a lender, pull your credit report. You want to know what’s being said about you. Look for any errors and correct them as soon as possible.
  • Consider boosting your score before moving forward: If your credit score is none too impressive, it might behoove you to wait before applying for a loan. Instead, use that time to work on improving your score so that when you do apply, you’re more likely to secure a competitive interest rate and terms.

The Takeaway

There are potential upsides to a collateralized personal loan, including potentially getting a lower interest rate, more money and more time to pay back the funds than you would with an unsecured personal loan. However, these upsides are largely due to the fact that the lender can seize your collateral if you fail to repay what you owe. As long as you’re confident you can successfully pay back a collateralized loan, it may be a viable option.Before moving forward with any lender, however, there are a variety of factors to consider, from term lengths, income requirements, fees and, of course, interest rates. You can easily view personal loan interest rates with Lantern by SoFi to find the most competitive rate for your situation. Taking the time to do so could make a difference in your monthly payments and how much you’ll ultimately pay over the life of the loan.
Photo credit: iStock/FG Trade
The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC112217

About the Author

Sheryl Nance-Nash

Sheryl Nance-Nash

Sheryl Nance-Nash is a freelance writer specializing in personal finance, business, and travel. Her work has appeared in Money Magazine, Newsday, The New York Times, Business Insider, BBC.com, AARP the Magazine, ABCNews.com, Forbes.com, among others.
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