Collateral is a valuable asset (like a car, house or even cash) you can pledge to secure a loan. If you fail to repay your loan, the lender can seize whatever you've put up as collateral. Financial institutions and other lenders usually consider loans secured with collateral less risky, and certain types of loans (such as mortgages) require collateral by default. Sometimes, you can offer collateral as an option to get a loan or a credit product you otherwise wouldn't be able to qualify for.
Below, CNBC Select explains how loans with collateral work, what you can typically use as collateral — and what you want to consider before doing so.
How does collateral work?
Collateral on a loan backs up your promise to repay the lender with a physical asset. Even if you default on your loan or credit card, the lender can recoup the loss by seizing the asset. This type of loan is also known as a secured loan — the collateral "secures" financing.
For example, if you take out a car loan, your new car becomes collateral and secures the loan. If you stop making payments on your loan, the lender can repossess the car.
Generally, the value of the collateral is sufficient to cover the lender's loss in case of loan default. When that's not the case, the lender may sue the borrower to collect the remaining balance. On the other hand, if you pay off the loan, the lender will remove their claim on your asset, meaning you'll now own that asset free and clear.
What can be used as collateral?
What kind of collateral you can use typically depends on the type of loan that needs securing. Here are the most common examples of assets lenders use as collateral:
- Vehicles: When you buy a car or other type of vehicle, that vehicle also secures your loan. Alternatively, you can use your car equity to get a title loan — but make sure you're aware of the risks first.
- Real estate: If you get a mortgage, the home you're buying will be the collateral. And if you've already bought a home, you can use your equity to secure a home equity loan or home equity line of credit (HELOC).
- Cash: In some cases, you can also use a deposit account as collateral, such as a savings account, money market account or certificate of deposit (CD).
- Investments: Investment accounts can serve as collateral as well, namely for a securities-based loan. This can be an installment loan or revolving line of credit with amounts ranging from 50% to 95% of what you have in your brokerage account.
- Valuables: Finally, valuable property or collectibles like jewelry, antiques and art can be collateral. When securing a loan using these types of objects, the lender will likely require that you submit a collateral appraisal to confirm their value.
What types of loans require collateral?
Secured loans are a common practice. Several types of loans are designed to use collateral, making it a requirement. These include
- Mortgages: A mortgage is perhaps the first type of secured loan that comes to mind. When you're taking out a mortgage to finance a home, the home becomes collateral. If you fail to make mortgage payments, you may lose your home to foreclosure, losing all the equity you've built.
- Auto loans: Following the same logic, the vehicle you're financing serves as collateral for your auto loan.
- HELOCs and home equity loans: The equity you have in your home can be collateral if you borrow against it. Note that you generally need at least 15% to 20% equity in your home to qualify for this type of financing.
When it comes to financing where the collateral is optional, some of the most common examples include
- Secured credit cards: Most credit cards are unsecured, but they also often require at least good credit (or a credit score of at least 670). Secured credit cards, on the other hand, are an excellent option for those with less-than-perfect credit. A secured credit card uses a cash deposit as collateral, and that deposit usually determines the credit limit of the card. Often the credit limit and the deposit amount are the same, but with the Capital One Platinum Secured Credit Card (see rates and fees), you have a credit limit of $200 even if you qualify for the minimum deposit as low as $49 or $99 deposit amount.
Capital One Platinum Secured Credit Card
Rewards
None
Welcome bonus
No current offer
Annual fee
$0
Intro APR
N/A for purchases and balance transfers
Regular APR
29.99% variable
Balance transfer fee
$0 at the Transfer APR, 4% of the amount of each transferred balance that posts to your account at a promotional APR that Capital One may offer to you
Foreign transaction fee
None
Credit needed
No credit history
See rates and fees. Terms apply.
- Secured personal loans: Usually, you don't need collateral for a personal loan. But some lenders will allow you to put up an asset as collateral if you have poor credit and otherwise wouldn't qualify for the loan (or qualify with terms you'd find unacceptable). Some examples of lenders that offer secured personal loans include OneMain Financial and Navy Federal Credit Union.
OneMain Financial Personal Loans
Annual Percentage Rate (APR)
18.00% to 35.99%
Loan purpose
Debt consolidation, major expenses, emergency costs
Loan amounts
$1,500 to $20,000
Terms
24, 36, 48, 60 Months
Credit needed
Poor/Fair
Origination fee
Origination fee starting at $25 to $500 or percentage ranging from 1% to 10% (depends on your state)
Early payoff penalty
None
Late fee
Up to $30 per late payment or up to 15% (depends on your state)
Click here to see if you prequalify for a personal loan offer. Terms apply.
Not all applicants will be approved. Loan approval and actual loan terms depend on your ability to meet our credit standards (including a responsible credit history, sufficient income after monthly expenses, and availability of collateral) and your state of residence. If approved, not all applicants will qualify for larger loan amounts or most favorable loan terms. Larger loan amounts require a first lien on a motor vehicle no more than ten years old, that meets our value requirements, titled in your name with valid insurance. APRs are generally higher on loans not secured by a vehicle. Highly-qualified applicants may be offered higher loan amounts and/or lower APRs than those shown above. OneMain charges origination fees where allowed by law. Depending on the state where you open your loan, the origination fee may be either a flat amount or a percentage of your loan amount. Flat fee amounts vary by state, ranging from $25 to $500. Percentage-based fees vary by state ranging from 1% to 10% of your loan amount subject to certain state limits on the fee amount. Visit omf.com/loanfees for more information. Loan proceeds cannot be used for postsecondary educational expenses as defined by the CFPB's Regulation Z such as college, university or vocational expense; for any business or commercial purpose; to purchase cryptocurrency assets, securities, derivatives or other speculative investments; or for gambling or illegal purposes.
Borrowers in these states are subject to these minimum loan sizes: Alabama: $2,100. California: $3,000. Georgia: $3,100. North Dakota: $2,000. Ohio: $2,000. Virginia: $2,600.
Borrowers in these states are subject to these maximum loan sizes: North Carolina: $9,000 for unsecured loans to all customers, $9,000 for secured loans to present customers. Maine: $7,000. Mississippi: $12,000. West Virginia: $14,000. Loans to purchase a motor vehicle or powersports equipment from select Maine, Mississippi, and North Carolina dealerships are not subject to these maximum loan sizes.
Example Loan: A $6,000 loan with a 24.99% APR that is repayable in 60 monthly installments would have monthly payments of $176.07.
Time to Fund Loans: Funding within one hour after closing through SpeedFunds must be disbursed to a bank-issued debit card. Disbursement by check or ACH may take up to 1-2 business days after loan closing.
Pros and cons of collateral loans
Like most kinds of financing, secured loans can be a useful tool — but they also come with potential disadvantages.
Advantages of secured loans
Besides the fact that using collateral offers you access to financing a home or vehicle, secured loans can provide a few other benefits.
For one, a secured loan or credit card can be an excellent choice for borrowers with limited or poor credit. Collateral can help improve approval odds, as well as offer a way to build credit with on-time payments.
Further, even if you already have stellar credit, opting for a secured personal loan may allow you to access larger loan amounts and get a lower interest rate.
Disadvantages of secured loans
At the same time, secured loans come with certain risks. Defaulting on such a loan can lead to losing the collateral. That doesn't mean you should avoid secured loans altogether. After all, collateral is a requirement for loans like a mortgage or auto loan — and most people don't have the option to buy a house or car without financing. But when you're considering a secured loan, it's imperative to understand the risk before you apply.
Additionally, a secured loan may involve a more complicated application process. For example, if you're using valuables like art or jewelry as collateral, the lender will normally request an appraisal.
Money matters — so make the most of it. Get expert tips, strategies, news and everything else you need to maximize your money, right to your inbox. Sign up here.
Bottom line
Collateral loans allow you to finance some of life's most expensive purchases, such as a vehicle or a house. They can also help borrowers with poor credit qualify for a credit card or personal loan. Still, as with any financing, it's crucial you understand the potential risks of secured loans — specifically, losing the collateral if you miss enough payments to default on the loan.
Catch up on CNBC Select's in-depth coverage of credit cards, banking and money, and follow us on TikTok, Facebook, Instagram and Twitter to stay up to date.
