How Does a Collateral Loan Work?

Collateral is essentially a form of asset that your bank can repossess in case you default on your loan repayment. It is usually documented on the loan contract agreement, giving the banking institution total control over the asset as compensation after default.

At this point, the lender may choose to sell off the collateral with the proceeds catering for a partial or full amount of the outstanding loan balance. A vast majority of consumer loans often rely on collateral giving rise to industry term, secured loans. 

What are the Different Types of Collateral? 

Collateral can vary depending on the type of loan obtained by a customer. For instance, for a car loan, the car itself is what will serve as collateral in case of a default. Likewise, a typical mortgage uses the home as collateral where the lender has the right to repossess the property in case you are unable to follow through on the loan repayments.

For companies and other forms of business establishments, any valuable equipment and assets are acceptable as a form of collateral. Take a look at these two common examples of collateral loans.

Personal Loans

On average, a consumer might opt for a personal loan when they need to improve their credit rating or find a solution for their day-to-day expenses. However, it can also be an excellent way to build on your credit rating and increase your borrowing power. The lender might either offer this type of loan either as a secured loan or an unsecured one.

The former is usually dependent on collateral while the unsecured loan type has no such requirement. The difference is in the amount of interest accrued to each, with the unsecured type attracting higher interest rates. This makes sense since there is a more significant risk taken on the lender’s part in case of a default. 

Small Business Loans

These kinds of loans are often made out in support of an emerging business establishment in its operations. Earlier this year, roughly $350 billion was released by the US government in support of small businesses. The funding could help businesses owners with bringing in new equipment, hiring new staff and catering for recurrent expenses.

Among the primary forms of collateral for this loan type are inventory and real estate assets. Additionally, the lender could also choose to take future payments by clients to the business as collateral. If the business owner operates from home, their assets could also serve as collateral.  

Take the First Step

There are other types of collateral loans you can look at, including auto loans and home mortgages. However, if you’re looking to access one in either of the two categories above, Heritage Bank is here to point you in the right direction.