Collateral is an asset you can pledge to secure a loan, such as real estate, a vehicle or a savings account. If you default on payments, the lender can seize whatever you've put up as collateral.
Some loans, like mortgages and car loans, require collateral by default. But collateral can also help borrowers with poor credit, lower income or other roadblocks get approved for a personal loan they might not otherwise be approved for.
Below, CNBC Select explains how collateral works, what can be used as collateral and what you to know before applying for a secured loan.
What is collateral and how does it work?
Collateral backs up your promise to repay a loan with a physical asset. If you default, the lender can recoup the loss by seizing the asset and selling it. This is known as a secured loan because the collateral "secures" the financing.
Using collateral reduces the risk lenders take, making them more willing to approve applicants with bad credit, lots of debt or less income.
They will typically only approve funding equal to or less than the value of the collateral. If you secure a loan with a car worth $10,000, your lender is not likely to let you borrow $20,000.
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If you use property as collateral, like real estate or a car, the lender usually puts a lien on the title. This gives them the right to take possession and sell the item at auction if you default. It also means you can't use the asset as collateral somewhere else or sell it to a third party.
There are usually restrictions on how you can use collateral. If you want to use your car as collateral, for example, you must typically own it outright — some lenders may also require an in-person inspection.
If you fail to make payments and the lender seizes your asset, you may be charged late fees and expenses associated with repossessing, preparing and auctioning the item. If it doesn't sell for at least the amount you owe, you may owe the deficiency balance.
What can be used as collateral?
The kind of collateral you can use depends on the lender and type of loan. The most common examples of collateral include:
- Vehicles: When you buy a car or other type of vehicle, it secures your auto loan. You can also use your vehicle to secure a personal loan.
- Real estate: With a mortgage, the home you're buying serves as collateral. If you' already own your home, you can use your equity to secure a home equity loan or home equity line of credit.
- Home fixtures: Some lenders allow you to use attached fixtures, like kitchen cabinets and bathroom vanities, to secure a loan
- Savings: A lender may allow you to use a savings account or certificate of deposit as collateral, but you can't touch your account while there's still a loan balance.
- Investments: Investment accounts can serve as collateral for a securities-based loan, which can be an installment loan or revolving line of credit.
- Valuables: Artwork, jewelry, antiques and other valuables may be accepted as collateral, but an appraisal is usually required,
What types of loans use collateral?
Several loan types use collateral.
Mortgages: A mortgage uses the property you are using the funds to purchase as collateral. If you default, the lender may foreclose on your home.
Auto loans: The vehicle you're financing serves as collateral for your auto loan.
Home equity loans and HELOCs: If you have enough home equity, you can use your house as collateral for a loan or line of credit you can use for debt consolidation, tuition or other needs.
Secured personal loans: If you have weak credit or low income, some lenders will allow you to put up an asset as collateral. Top lenders that offer secured personal loans include OneMain Financial and Upstart.
We like that OneMain accepts borrowers with bad credit and offers secured loans and fast funding. However, its minimum APR is on the high side and the $30,000 financing maximum may be too low if you need a larger loan.
- Approves applicants with bad/fair credit
- Same-day funding available
- Can apply with collateral
- Co-applicants allowed
- High origination fee
- High minimum interest rate
- No autopay discount
- Co-signers not allowed
*You must complete a loan application and continue to meet any criteria used to select you for a loan offer. Not all applicants are approved. Loan approval and actual loan terms depend on applicant's state of residence and ability to meet OneMain Financial credit standards such as a responsible credit history, sufficient income after monthly expenses, and if applicable, availability of eligible collateral.
Not all approved applicants qualify for larger loan amounts, lower APRs, or the most favorable loan terms. For example, larger loan amounts typically require a first lien on a motor vehicle that is no more than ten years old, meets our value requirements, and is titled in applicant's name with valid insurance. APRs are generally higher on loans not secured by a vehicle.
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.
OneMain charges origination fees allowed by law. Depending on the state where the loan is opened, the origination fee may be either a flat amount or a percentage of the loan amount. Flat fees vary by state, ranging from $25 to $500. Percentage-based fees vary by state, ranging from 1% to 10% of the loan amount subject to certain state limits on the fee amount.
For information about these fees and minimum and maximum loan sizes available in certain states, visit omf.com/loanfees.
Current OneMain Customers: Loan offers presented to a consumer assume the individual has no active loan with OneMain or one of its affiliates. If a customer applies for a new loan offer, a OneMain representative will discuss available options.
Active-duty military, their spouse or dependents covered by the Military Lending Act (MLA) may not pledge any vehicle as collateral. If you are covered by the MLA, you are not eligible for secured loans.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.
Time to Fund Loans: Funding within one hour after loan 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 closing.
We like that Upstart considers factors besides credit score, including education, income and employment history. However, co-signers aren't accepted.
- Accept applicants with bad or no credit
- Minimum APR is lower than many competitors'
- Approves personal loans up to $75,000
- Most loans are funded the next business day
- Origination fee of 0% to 10%
- Doesn't allow co-signers or co-borrowers
Secured credit cards: Most credit cards are unsecured but there are secured credit cards that use a cash deposit as collateral. Often the deposit amount and your credit limit are the same, but with the Capital One Platinum Secured Credit Card, you may qualify for a credit limit of $200 with a deposit of just $49 or $99.
The Capital One Platinum Secured Credit Card can help you build, or rebuild, your credit because you can be approved with no credit or bad credit.
- No annual fee
- Low minimum refundable security deposit starting at $49 to get a $200 initial credit line
- No foreign transaction fees
- No rewards on purchases
- No welcome offer
- High APR
Highlights
Highlights shown here are provided by the issuer and have not been reviewed by CNBC Select's editorial staff.
- No annual or hidden fees. See if you're approved in seconds
- Building your credit? Using the Capital One Platinum Secured card responsibly could help
- Put down a refundable security deposit starting at $49 to get at least a $200 initial credit line
- You could earn back your security deposit as a statement credit when you use your card responsibly, like making payments on time
- Be automatically considered for a higher credit line in as little as 6 months with no additional deposit needed
- Enjoy peace of mind with $0 Fraud Liability so that you won't be responsible for unauthorized charges
- Monitor your credit score with CreditWise from Capital One. It's free for everyone
- Get access to your account 24 hours a day, 7 days a week with online banking to access your account from your desktop or smartphone, with Capital One's mobile app
- Top rated mobile app
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
Pros and cons of collateral
Like most kinds of financing, secured loans have distinct benefits and drawbacks.
Pros of secured loans
- Borrowers with bad credit or lots of debt can get approved for financing.
- You may be approved for a larger loan or longer terms.
Cons
- Defaulting on such a loan can lead to losing the collateral.
- Approval time may be longer for secured loans
- Not all lenders offer secured loans
- Each lender has limits on what can be used as collateral
Is using collateral for a loan a good idea?
Taking out a secured loan with collateral can be a good idea, but it depends what you're pledging and whether you can comfortably repay the loan.
Using collateral can be a good idea if you have bad credit or a thin credit history, lots of debts or other red flags that will make it hard to get approved for an unsecured loan. It's also worth considering if you can get a meaningfully lower interest rate than with an unsecured loan.
You should only consider using collateral if you have a solid repayment plan and enough income to handle both the monthly payments or unexpected expenses.
Think carefully before putting up something for collateral that would seriously disrupt your life if you had to forfeit it, like your sole vehicle.
Using collateral could be a bad idea if your income is uncertain and repayment could become difficult.
Ultimately, while collateral can make borrowing cheaper, you're exchanging a lower borrowing cost for higher personal risk.
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