What Can Be Used as Collateral for a Personal Loan?

Some personal loans require collateral — that is, a personal asset, such as a car, home, cash deposit or investment — that you offer to secure the loan. This asset reduces the lender's risk, as you'll forfeit it if you can't repay the funds as agreed. Given this arrangement, collateralized personal loans often carry lower interest rates than unsecured personal loans.

Learn more about what can be used as collateral for a personal loan and how to determine if using an asset to secure funding is your best move.

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Do All Personal Loans Require Collateral?

Not every personal loan requires collateral. In fact, most personal loans are unsecured, meaning lenders approve financing based on your credit, existing debts and income.

Secured personal loans, on the other hand, require an asset to back the funds. Lenders often require collateral when an applicant has poor or no credit. They may also require collateral to secure a loan if the amount is high.

The big drawback to a secured personal loan is that you risk losing the asset if you fail to repay the lender. The upside is that you could qualify for a lower interest rate or a higher financing amount.

Plus, "the bank may not approve [you] if there's no collateral for the loan, so it could be a situation of getting approved or getting denied," said Hugh Steven Morris, Chartered Retirement Planning Counselor (CRPC) and president at The Morris Group.

Here's a comparison of secured vs. unsecured personal loans.

Common Types of Collateral for Personal Loans

You can commonly use the following items as collateral for a personal loan:

• Vehicles, like cars, boats or motorcycles

• Savings, like cash or a certificate of deposit (CD)

• Collectibles, like fine art, wine and sports memorabilia

• Precious metals, like silver, gold and platinum

• Jewelry, diamonds and gemstones

• Investments, like stocks, bonds or insurance policies

• Real estate, like your land or home, provided you have enough equity

• Future paychecks, though, in this instance, failure to repay can result in wage garnishment

How Collateral Affects Loan Terms: Benefits and Risks

Collateral can impact your loan terms in several ways.

• Ups your odds of approval: Bad credit or no credit can result in a loan denial. Collateral reduces the risk to the lender and, therefore, can make them more likely to extend the financing.

• Helps you qualify for more money: Higher loans represent higher risk to lenders. If the borrower defaults, they'll lose more money. Collateral allows them to recoup at least some of those funds, and so could net you a larger loan.

• Could lower your interest rate: A secured personal loan tends to carry lower annual percentage rates (APRs) than its unsecured counterparts, given that the collateral serves as a security measure.

• Risks your physical or financial property: "The asset serving as collateral is tied to the loan until it's fully repaid," said Brian Samelko, vice president of personal lending at PNC Bank. "If the borrower can't repay, the lender has legal rights to claim the asset to help recover the debt."

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When Lenders Might Ask for Collateral

Lenders ask for collateral when they consider an applicant to be high-risk. Collateral requests are commonly tied to:

• A poor credit scores, which result from possibly misusing loans in the past. It might suggest you have trouble paying new financing as agreed.

• No credit history, which hinders lenders from assessing your borrowing risk.

• High debt-to-income ratios, which indicate existing debts, might suggest you aren't able to pay new loans on time and in full.

• Lack of a stable income, which could leave you short on funds to repay the lender.

• Borrowing large amounts, which would result in steep losses to the lender if you default.

Some lenders only offered secured loans also. For instance, pawn shops require lenders to put an item up as collateral before they'll provide short-term funding.

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What Happens if You Default on a Secured Loan?

If you default on a secured loan, the lender can seize the collateral via repossession, foreclosure or wage garnishment. These items can appear on your credit report and negatively impact your credit score. Missed payments on secured loans can also harm your credit and result in late fees.

To avoid defaulting on a loan, keep these rules of thumb in mind:

• Avoid over borrowing

• Understand all the terms and conditions of your loan agreement

• Create a budget that includes your monthly payment

• Contact your lender if you're at serious risk of default or missed payments

"Lenders typically work with borrowers before taking action such as repossession or foreclosure," said Samelko. "The goal is for both borrower and lender to benefit by seeing the loan repaid on time and the collateral remain untouched."

Alternatives If You Don't Want To Use Collateral

Consider these alternatives if you can't or don't want to use an asset to back a personal loan.

Unsecured Personal Loans

If you have good credit, you can often qualify for a personal loan with favorable terms without having to put up collateral. These loans are also a good option if you're not looking for a large amount of funds.

Credit-Builder Loans

If you mainly want to build credit, consider a credit-builder loan. These loans help you establish a credit history by making small monthly payments into a savings account. You receive the funds, plus interest, upon completion of the loan term.

Peer-To-Peer Lending

These alternative loan marketplaces connect borrowers with willing financiers who sometimes impose less stringent lending requirements. There are drawbacks to peer-to-peer lending, such as higher interest rates.

Co-Signed Loans

If you have bad credit but no collateral, a creditworthy cosigner may be able to convince a traditional lender to offer you a loan. That co-signer will get penalized for any missteps during the repayment term, however.

Credit Cards With Promotional Rates

Balance transfer or 0% APR credit cards allow you to skip interest on a transferred balance or large purchase for a set period, typically 12 to 21 months. They're an option if you can repay the balance before the intro period ends, though you'll likely need at least good credit to qualify.

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How To Decide if Using Collateral Is Right for You

Collateralized loans aren't always ideal, given that they require you to risk an asset for funding. However, they're an option if you can't otherwise get approved for or secure favorable terms on unsecured financing. Here are some scenarios to help with your decision process.

Collateral loans are a good fit if:

• You have an asset to offer as collateral.

• You have bad credit and can't qualify for unsecured loans.

• You have no credit history and can't qualify for traditional financing.

• You're looking to rebuild or build credit.

• You're looking to borrow a large amount of money.

Collateral loans aren't a good fit if:

• You don't have an asset to offer as collateral.

• You can't make the monthly payments and, therefore, could lose the property.

• You have good credit and can qualify for more favorable financing terms.

• You're looking for fast cash as collateral review can take some time.

"When managed responsibly, secured personal loans can be a good financial tool," Samelko said. "The keys are discipline and diligent planning. Borrowers should make sure repayment fits comfortably into their budget and the loan serves a clear financial purpose."

FAQs

What is the most common form of collateral for personal loans?

Cash deposits are among the most common forms of collateral for personal loans. Other common forms of collateral include vehicles, collectibles, fine jewelry, precious metals, investments and real estate.

Can I use my car as collateral if it's not paid off?

You can use a car that's not paid off yet as collateral if you have enough equity — i.e., own enough of it — to cover the lender's requirements.

Can I use my house as collateral for a personal loan?

You can use your house as collateral for a personal loan if you have enough equity to cover the lender's requirements. Home equity is the amount of your house's value that you own outright.

What happens if I sell the collateral before paying off the loan?

Unless the lender approves the sale, selling collateral may be considered a violation of your loan agreement, which can then lead to legal action being taken against you.

Photo credit: Eva-Katalin / Getty Images

Sources

• AFFCU. "What Can Be Used as Collateral for a Personal Loan."

• Federal Trade Commission (FTC). "Did a lender offer less favorable terms or deny you credit?"