How Does a Loan With Collateral Work?

secured loans (also called collateral loans)

Borrowing money when you don’t have a savings account is often challenging. It can be especially problematic for people with less than perfect credit history, as it increases the lender’s risk of losing the funds. However, even with bad or poor credit, you can still borrow money for your needs. A loan with collateral is an excellent choice in such situations, as it increases your chance of getting approved and decreases risk for the lender. 

Keep reading to learn more about secured loans (also called collateral loans) and when to apply for these financing options. 

What Is a Collateral Loan?

Secured loans are borrowing options where lenders require a valuable asset in order to give you money. Depending on the type of loan, you can use your house, car, cash deposit, or investment accounts to secure a loan. 

This type of personal loan helps you get a more significant amount with a low-interest rate and better approval odds despite your bad credit. 

How Does a Secured Loan Work?

When applying for loans that require collateral, you need to offer a valuable asset as collateral. This type of personal loan is safer for lenders, as they can possess your home, car, or any other valuable asset if you don’t repay the debt. If you have a bad credit rating, offering a physical asset as collateral can increase your chance of approval. You can apply for a loan with a 500 credit score or lower. The size of your collateral should cover the total loan sum. Otherwise, if you don’t return the funds, you will need to repay the remaining balance. However, due to the risk of losing your personal asset, a secured loan is considered high-risk and should not be your first option.

Forms of Collateral 

You can provide your lender with collateral if you need to borrow a larger loan amount than it can offer. To secure a loan, you can use various types of collateral, such as: 

  • Vehicle;
  • Savings account;
  • Property;
  • Insurance policy;
  • Jewelry; 
  • Investment portfolio. 

How to Apply for a Secured Loan?

The application process for a collateral loan is generally more complicated than for unsecured loans. To get approved, take the following steps: 

1. Check Your Credit 

Your credit score is one of the most important factors for your potential lenders. Therefore, don’t forget to check it before applying. 

2. Prequalify for a Loan 

Prequalification can show your chance of getting approval for a loan. Many lenders offer this option for free, so don’t miss it!

3. Compare Lenders

Various loan providers offer different loan terms, APR (annual percentage rate), and fees (prepayment penalties). Although collateral loans have lower interest rates than unsecured ones, it is essential to analyze all the offers to choose the most favorable one. 

4. Collect Documentation 

Lenders need specific documents to approve your application. Although their requirements may differ, most lenders need your bank statements, pay stubs, tax documentation, and other documents presenting your current financial situation and income. 

5. Send a Loan Request

After collecting the required documents, you need to submit them and send your loan request. 

6. Receive the Funds 

Various lenders deposit funds in different terms. While several loan providers can transfer the money on the same day, orders can do it for up to two months. 

What Are the Types of Collateral Loans?

There are various types of loans secured by collateral, allowing everybody to find the necessary solution. If you are looking for secured loans, pay attention to the following options: 

Car Loans 

An auto loan is a standard example of a collateral loan. People apply for this loan using a car as collateral.  It means the lender can keep your vehicle if you don’t return the debt on time. 


In mortgages, people borrow money from a financial institution using a house as collateral for a loan.  Thus, you can lose your home if you do not repay the funds.   

Secured Credit Cards 

Getting an unsecured credit card may be challenging if you don’t have a good credit history. Therefore, you can consider secured credit cards to get the necessary amount. 

When opening the account, you must pay a security deposit. If you make all the monthly payments timely, secured credit cards can help you to improve your credit history.  

Business Loans

You can use business loans with collateral to finance your business projects and buy equipment. In this type of loan, the lender can possess your inventory or land if you fail to repay the money.  

Home Equity Loans 

A home equity loan (second mortgage) is secured by the equity of your home. Unlike mortgages, if you can’t repay a home equity loan, the lender can seize only your home’s equity, not the entire house. 

Home Equity Lines of Credit

A home equity line of credit works similarly to credit cards, allowing borrowers to withdraw from a revolving line of credit, return it, and use it as many times as they want. This type of loan is often used for home renovation or improvement. 

Secured Personal Loans 

A secured personal loan is convenient for many borrowers. The main advantage of this personal loan is that you can use it for various purposes: from debt consolidation to car repairs. While personal loans can be both secured and unsecured, the collateral loan rates are lower and more affordable for borrowers. 

Where to Apply for a Secured Loan? 

If you want to apply for extra cash with collateral, you can choose from several lenders, such as: 

Traditional Banks

A traditional bank is the most standard financial institution where you can receive additional money. The most important thing is to have a bank account in the institution where you are applying. 

Credit Unions

Another place to apply for a loan with collateral is a credit union. However, you must be its member to get approved. 

Pawn Shop Loans

Pawn shop loans are short-term loans allowing you to get a loan secured by collateral. However, applying for this type of loan, you risk losing your collateral, as pawn shops often come with high-interest rates. 

Online Lenders 

If traditional loan options don’t suit you, you can apply for a loan through online lenders. Many online loan providers require collateral, allowing borrowers to receive more convenient repayment terms and lower interest. 

Auto Dealerships 

An auto dealership is an excellent loan option for buying a car. Automakers generally require collateral but, at the same time, offer a convenient loan term. 

Pros of Collateral Loans

Collateral loans may be a suitable option for many borrowers, as they provide people with the following benefits: 

Available with Poor or Bad Credit 

Secured loans are safer for the lenders, as in the case of your failure in loan repayment, they can seize your personal assets. Therefore, unlike unsecured personal loans, collateral loans are affordable even for bad credit borrowers. 

Lower Interest Rates 

Secured loans generally offer lower interest rates than unsecured ones, so collateral loans may be a suitable option if you don’t want to lose cash by paying high interest.. 

Building Credit 

As most lenders report your on-time payments to the main credit bureaus (Equifax, Experian, and TransUnion), collateral loans can help you build your credit score. 

Borrowing a More Significant Amount 

While it may be challenging to borrow a significant amount in an unsecured loan, collateral loans help people obtain the necessary sum.

Cons of Collateral Loans

Applying for a secured loan also has specific drawbacks, such as the following: 

Risk of Losing Your Asset 

The primary risk of unsecured loans is that you can lose your collateral. Therefore it is important to apply for a collateral loan only if you ensure you can repay it. 

Having a Valuable Asset 

One of the main cons of collateral loans is that not all borrowers have valuable assets to offer as collateral. 

More Complicated Application Process

The application process for a collateral loan generally takes longer than for an unsecured loan. However, the time can differ depending on the specific loan provider. 

Alternatives to a Collateral Loan 

There are more convenient ways to borrow money than a collateral loan. Therefore, you can consider such options as: 

Credit Unions 

Credit unions allow their members to receive unsecured personal loans with lower interest rates than unsecured loans from online lenders. 

Unsecured Personal Loans

You can get an unsecured loan from an online financial institution despite your bad credit. However, you may need to pay an interest rate higher than for a secured loan option. 

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