What is Collateral Loan? Meaning, Types, & How it Works

Borrowers often feel that keeping some kind of collateral such as assets, property, vehicles, etc. helps in faster loan approval. Long-term loans, also known as secured loans, are generally those above Rs 5 Lakh are considered as collateral loans. Lenders request collateral against a large loan amount being sanctioned. Keeping collateral against a loan amount acts as a safety net for the lenders in case of defaulters. In such cases, the collateral can be used to recover the pending loan amount.

One of the benefits a collateral loan offers is a low interest as the loan tenure is lengthy and also a valuable asset is deposited against a loan. There are different types of collateral loans – mortgage loans, home loans, automobile loans, real estate loans, etc.

Online lenders: Check for secured loan options online on personal loan apps.

Bank Funding: Better apply for collateral loans with your existing bank to get better interest rates throughout the loan tenure.

Automobile Dealers: Depending upon the vehicle amount, auto dealers approve of collateral loans on new purchases. A good credit score is of help here.

What is Collateral Loan?

A collateral loan is a loan secured by an asset that can be used to assure repayment of the loan. When you apply for such a loan, you will need to offer an asset that the lender will be able to quickly sell for repayment if you do not pay the loan. Your loan will be dependent on the collateral. The lenders offer a pre-set percentage of your collateral as a loan. For example: when you apply for a Loan Against Property at Hero FinCorp, you can get a loan amount of up to 75% of your property’s market value.

Procedure for applying for collateral loan:

1. Examine your credit score – The higher your score, the better interest rate you'll receive.
2. Shop lenders – Use your due diligence to find the best loan terms, rates, and fees.
3. Prepare the necessary documentation – It may involve things such as income documents, proof of assets, and disclosures about debts.
4. Complete the application – Once you have the items listed above, submit your loan application.
5. Approval and disbursement – After processing, the lender will approve your loan and will transfer the funds to your account.

Also Read : Can a person have a personal loan and a home loan simultaneously

Types of Collateral Loans

There are several types of collateral loans you can avail of depending on the asset you want to use:

1. Loan Against Property (LAP):

You can use your property (residential or commercial) as collateral to secure a loan. This type of loan usually has lower interest rates and larger amounts, thus being a good option to raise larger sums.

2. Loan Against Gold:

Gold as collateral can include coins, bars, and jewellery. Gold has a substantial value and is the most common commodity used to take a secured loan.

3. Loan Against Securities:

You can use securities (shares, bonds, mutual funds, etc.) as collateral for a secured loan. Generally, loans secured with securities have a lower loan-to-value ratio since the value of the securities can fluctuate.

4. Loan Against Fixed Deposit:

If you have a fixed deposit or FD, it can be used as collateral to take a loan. Usually, the loan amount is a percentage of the FD and this type of loan comes with lower interest rates.

5. Machinery Loan:

Businesspersons can use machinery or equipment to get loans for business expansion or operations.

Also Read : All About Loans

Pros and Cons of Collateral Loans

Pros:

• Low interest rates: The rate of interest on collateral loans is lower than unsecured loans as the collateral reduces the lender's risk.
• Higher loan amount: The collateral value determines the loan amount, which can be more than that of an unsecured loan.
• Easier approval even for low credit scores: These loans are available to even those with low or poor credit scores as the collateral reduces the risk to the lender.

Cons:

• Risk of losing your asset: You risk losing your asset if you default on the loan. In simple words, the lender can sell your asset to recover the loan if you fail to repay.
• Complicated application process: The process of applying for a collateral loan may require more documents for verification than in an unsecured loan.
• Asset requirement: This loan is available only to those who have valuable assets to pledge as collateral.

Also Read : Payday Loans in India‚ What Is a Payday Loan and How It Works in India?

Steps to Apply for Collateral Loan

1. Check your credit score in advance to get the best interest rate on collateral loans
2. Compare with at least three lenders to acquire the best loan terms and lender fees
3. Prepare documents to submit that reflect your income, financial status, and debts, if any
4. Verify with your lender for any pending paper-work for collateral loan approval
5. Receive the loan amount within a week’s time. It doesn’t function on an instant basis as the loan amount is large and the lender needs time for a background check.

Why Choose a Collateral Loan?

Collateral loans, or secured loans, are the best way to get a large amount of money that you can use for different purposes, such as expanding your business, organising a destination wedding, higher education or foreign travel. It is also apt for individuals with bad or poor credit scores. As the loan is secured by collateral, the lender can offer you more favourable terms, like reduced rates of interest and a higher amount of the loan. But remember that there are risks involved in such loans, like losing the property if you cannot repay the loan within time.

Also Read : Understanding What is Flexi Personal Loan and When it is Ideal

Mismanagement of Collateral Loans

A collateral loan has a default period of 30 days. After this, the lender may offer a grace period to clear the loan amount. Even after the grace period is missed, some lenders may discuss the reasons for the delay and offer some revised payment plans for ease of payment. However, even after the undertaken steps to clear the obligation, if the loan remains unpaid, borrowers may lose their collateral due to mismanagement of finance or various other reasons best known to the borrower.

Though there is a high risk to lose the mortgaged asset, collateral loans still exist, as a considerable loan amount is offered at one go. Those who are looking for emergency loans or want to deal with a shortage of funds should choose a safe option of collateral-free, unsecured loans also known as instant personal loans. Small cash loans approve a limited amount of money up to a couple of lakhs instantly. Being a shorter tenure loan, instant personal loan are approved with zero collateral. Hence, based on the urgency of finance, choose a wise credit option. A collateral-based loan is only advisable to take when you are sure about clearing the loan on time, without putting the asset at stake. Losing the asset along with defaulting on the loan account will affect the credit score negatively.

Conclusion

If you need a bigger loan amount with lower rates of interest, then a collateral loan is the best choice. It can offer you a loan with low interest rates and longer repayment tenures even with a low or poor credit score. It is better to evaluate your expenses and finances thoroughly before taking this loan, as failure to repay the loan can lead to the seizure of your property provided to the lender as collateral.

At Hero FinCorp, you can take a Loan Against Property (LAP) of up to Rs 7.5 Crore at low interest rates and extended repayment periods of up to 15 years without much formalities.

Frequently Asked Questions

What is collateral for a loan in simple terms?

Collateral, in simple words, is a security or assurance you provide to the lender for taking a secured loan.

Is property considered collateral?

Yes, both commercial and residential properties can be provided as collateral for a loan.

What will happen if I don’t repay my collateral loan?

If you cannot pay back the loan backed by collateral, like your home, the loan provider may sell it to recover the loan.

What assets can I pledge as collateral?

You can use your property (home or office), gold, vehicles and even investments like stocks, bonds, mutual funds as collateral.