When you, as a consumer, borrow money from a bank or financial institution, it is carefully examined how much you can borrow based on your income and circumstances. Unfortunately, sometimes that is less than you need in practice. A solution may be to borrow against collateral. You then use your car or house as collateral, so that you can borrow a higher amount than you would normally be allowed to borrow. What are the advantages of a loan with collateral and what are the possible risks?
What is collateral borrowing?
When borrowing on collateral, you use one of your assets as collateral for the loan you want to take out. By offering the lender, bank or financial institution more security, they can offer you as a consumer more favorable conditions. You pay relatively less interest for a loan with collateral than for a personal loan or revolving credit. You can also usually get a higher loan if you are willing to provide collateral for the loan. If you want to borrow more than the financial institution is willing to provide, it may be an idea to see whether the maximum loan amount can be increased in this way.
What assets can be used as collateral?
In principle, anything that has value can be used as collateral. In practice, commonly used collateral is your own house, car or boat. However, the mortgage on these (immovable) properties is also eligible and can be offered as collateral. In addition, it often happens that life insurance policies are used as collateral for a loan if they contain built-up capital. Shares and bonds also represent value and are therefore often accepted as collateral by the lender. Gold, jewelry and antiques are also accepted, but usually not by the larger banks and insurers.
What are the advantages of borrowing with collateral?
Because the lender has less risk of not getting back its investment, the terms of the loan will generally be better. It is also often possible to borrow more than would be the case without collateral. If you want to borrow at a relatively more favorable rate or want to borrow more than you could borrow according to the calculations, a loan with collateral is a good alternative to other forms of borrowing. Even if your borrowing history is not flawless, a collateral loan may make the lender decide to give you a loan after all.
Are there risks associated with taking out a loan with collateral?
If you cannot repay the loan or temporarily lag behind in payments, the bank or financial institution can realize your collateral. You then really lose what you provided as collateral as a condition for the loan. So ask yourself whether you want to take that risk with your wedding ring or your deceased grandmother’s antique cupboard. When a collateral is sold by the lender, there is a chance that it will yield less than it would if it were sold under more normal circumstances. Consider, for example, forced foreclosure sales of homes, where the proceeds are often much lower than the normal free sale value of the property.
Loan with collateral or not?
If you are sure that you can actually repay the loan, a collateral loan is a very good alternative to a personal loan or revolving credit. If there is a chance that you will default on repayments, be aware that you could actually lose the collateral. In that case, do not use assets as collateral that have too high (emotional) value for you or your family, such as heirlooms, and if you need the car for work, do not risk it without thinking.