Loans can be divided into two segments, secured and unsecured. While the secured loan consists of a loan against security, unsecured loans are primarily extended by banks and financial institutions without seeking any security from the borrower. One of the prominent loans is collateral loans. However, before understanding it, let’s understand what collateral securities are!
How do collateral loans work?
When you apply for a collateral loan, the lender requires you to pledge an asset such as a property, vehicle, or personal assets like jewellery as collateral. The loan amount you can borrow is typically determined by the value of the collateral you provide. Lenders often offer loans ranging as a percentage, usually 50-80%, of the appraised value of the collateral. Moreover, collateral loans generally have lower interest rates than unsecured loans because the collateral reduces the lender’s risk. The rate may vary based on factors such as the type of collateral, loan amount, and creditworthiness.
What Is Collateral Security?
There are two types of securities, primary security and collateral security. Primary security is the security that is created out of the loan facility extended to the borrower. In case, any other security is offered against the loan, that security is known as collateral security.
For instance, if the funds are borrowed for buying a loan, then the home will be regarded as primary security because it is created out of the funds availed from the loan. However, if the borrower also provides a fixed deposit (FD) as security to the lender, then the FD will be considered collateral security.
Types of Collateral Loans
Here are some common types of collateral loans:
- Loan Against Securities: Here, banks and financial institutions extend a loan against securities that can include shares, mutual fund units or bonds. As the assets are riskier and involve volatility, the loan to value (LTV) is a bit lower as compared to loans against other asset classes.
- Loan Against Property: Here, borrowers can avail of a loan against providing their real estate property as collateral security. This is one of the most common types of collateral finance availed of by borrowers primarily because it attracts lower interest rates, and they can borrow a significant amount by providing property as collateral security. Real estate property is less volatile and serves as a secure asset for the lender. Further, loan against property can be availed of against both residential and commercial properties.
- Loan Against Gold: This is yet another loan against collateral option for the borrower whereby they can pledge gold against borrowing funds from the lender. Gold also serves as a secure asset, making them eligible for financing.
- Loan Against FD: FD can also be used as collateral security for borrowing money from banks and financial institutions. FDs with banks involve a lock-in period. Premature withdrawal of FDs can attract penal charges and loss of interest for depositors. Therefore, a good way out is to secure a loan against the FD by providing it as collateral. Additionally, many institutions offer setoff of the FD interest income against the loan, reducing the net interest rate on the loan.
- Machinery Loan: Banks and financial institutions provide borrowing facilities by accepting machinery as collateral securities. Usually, this serves as a relief to business professionals who require financing but don’t want to pledge their personal assets as collateral.
Other examples of collateral loan include loans against insurance policies, valuable items, accounts receivables and inventory.
Pros & cons of collateral loan
Here are the pros and cons of a collateral loan-
Pros-
1. Lower interest rates
2. Higher loan amounts than unsecured loans
3. Quick approvals
4. Helps borrowers build credit and improve credit score
Cons-
1. Risk of losing collateral
2. Loan eligibility can be limited to borrowers with valuable assets to pledge.
Examples of Collateral Loans
Lenders offer various types of collateral loans, such as
1. Loan against property
2. Loan against securities
3. Loan against FD
4. Machinery Loan
5. Loan Against Gold 6. Auto Loan
What Are the Charges Involved in Collateral Loans?
The charges involved for availing of a loan against collateral vary among lenders. Moreover, it depends upon the type of collateral loan that you want; whether it’s a loan against property, vehicle, fixed deposit, gold or any other asset. However, as collateral loans are secured loans, the collateral loan interest rates are quite lower compared to the unsecured lending arrangements.
How to apply for a collateral loan?
Here’s how you can apply for a collateral loan-
1. Compare loan options from different lenders
Different lenders will carry varying loan features and requirements, so it is best to apply for prequalification with multiple lenders to compare loan options. To pick the best option, you can compare the loan eligibility, repayment tenures, and additional charges.
2. Check your credit score
Before applying for a collateral loan, check the lender’s income, age, or credit score eligibility criteria to ensure a smooth loan process. Since credit score is critical, ensure a high credit score before applying to ensure loan approval.
3. Submit the application with documents
Apply with the lender online or offline, along with the necessary personal and income documents to complete the application process.
4. Receive the funds
Once the documents are verified, the lender will approve your loan and disburse the amount within a few days or weeks.
Closing Thoughts
Collateral loans have always been a saviour in times of emergency. One of the foremost benefits available to borrowers is that collateral loan provide them access to capital that otherwise is blocked in the asset. A borrower can use this loan to meet emergencies as well as fund their business and expansion plans. With the advent of technology, now you can easily avail of a low-interest collateral loan online. Visit Tata Capital’s website and apply for a collateral loan online now!
12 July 2024
5 mins read
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