Most Americans have some form of debt, with the average household carrying $101,915 in debt at the end of 2022. A collateral loan may be the right option if you need cash for a large expense – although it comes with risk. Taking out a collateral loan involves securing the loan by pledging something valuable, such as your home, car, or savings account. So, if you fail to repay the loan as agreed, the lender can take the asset deemed as collateral. However, collateral loans offer benefits like lower interest rates and potentially easier approval. It’s essential to weigh the pros and cons of collateral loans to make the right choice for your needs and financial situation.
Types of collateral loan
A home equity loan is a common type of collateral loan that allows you to borrow against the equity in your home. The loan amount is based on the difference between your home’s current value and your current mortgage balance due. This type of loan allows you to access the equity (cash) tied up in your home – which can be particularly useful if you plan on using that cash for home improvements to boost your home’s value even further.
Alternatively, a secured personal loan is another common type of collateral loan. It can be used for major expenses like home improvements or debt consolidation. They’re often offered as an alternative to unsecured loans, allowing you to borrow money without collateral. Unsecured loans do, however, typically come with higher interest rates. When choosing between a secured or unsecured loan, it’s important to do your research before signing the dotted line. Only borrow what you can afford to repay.
Advantages of collateral loans
Since they’re less risky for lenders, collateral loans typically have lower interest rates than unsecured loans. You may also find it easier to qualify for a loan – even if your credit isn’t great. So, this can be a practical option if you have a short credit history, for instance. Similarly, collateral loans can make it easier to obtain bigger loans, although the exact amount depends on the value of your collateral. Collateral loans also offer short-term liquidity. That means they allow you to access the money tied up in your assets without you having to sell off these items.
Disadvantages of collateral loans
It’s also important to consider the disadvantages of collateral loans. You can lose the collateral – your house, car, or money – if you don’t pay the loan back on time. You should therefore devise a realistic repayment plan you’re able to stick to when going this route. Moreover, you also need to own something of value to qualify for a collateral loan. So, if you’re unable to qualify for an unsecured loan, you may not be in the position to come up with the collateral needed to obtain this type of loan either.
Collateral loans can increase your borrowing power while lowering your interest rate – even if you have a poor credit history. By weighing the pros and cons of collateral loans, you can make the right decision for your financial situation.
