�Loan� is the money borrowed by the lender from the borrower. Now loans can be for personal use or business needs. Both of these loans can be secured or unsecured. If it�s an unsecured loan, you do not need any collateral to get it. Why? Because such loans are granted based on your creditworthiness which is judged by your credit score. However, in the case of a secured loan, banks ask you for collateral, without which you cannot avail of the loan.�
Are you wondering why anyone would go for a secured loan when they can get the loan without pledging any property? Well, here�s the thing, the interest rates levied on unsecured loans are way too high, which makes the amount skyrocket.
Now that you know the basics of a loan, let�s dive into what collateral is and why lenders ask for collateral while lending.
What Is Collateral?
Collateral is an asset fully owned by the borrower which acts as a guarantee against the credit given. While going for a secured loan, you must provide collateral against it. This is because lenders need security based on which they trust you with the loan. If you fail to repay the loan, the lender has all the rights to auction it or sell the property to realize their principal amount.
As the secured loans have a full-blown asset as backing, you are charged a lower interest rate, unlike in the unsecured ones. The lower the risk, the lower the interest rate! We suppose now we�re quite clear about the basics of collateral. So, let�s move on and learn about its types.
Here are seven kinds of collaterals that you can consider while taking up a secured loan:
- A fully-owned real estate property.
- Your savings account or a fixed deposit you�ve built for the past years.
- Any commercial or residential property under your ownership.
- A private vehicle that you�ve bought which has no EMIs going on.
- Stocks, Mutual Funds, Bonds, or any investment you�ve made in the stock market.
- Valid/Ongoing insurance policies that you�ve been paying premiums for.
- Precious metals or high-value items.
If you successfully provide any of the above to the bank, you open your doors to a high loan amount at a low-interest rate. Also, in case of non-payment of the EMI, the lender�s right is limited to the collateral provided by you.�
3 Reasons Why Lenders Ask For Collateral While Lending
If you are planning to get a secured loan, you cannot borrow any amount from the lender without keeping your asset as a backup. Here�s why:
1. Lowers the Chances of Repayment Failures
Collaterals make the chances of defaults of payments of the principal plus interest multiple times lower. Why? Because the assets kept as collateral are highly valuable, borrowers cannot afford to lose them.
2. Safety for the Lender
Having collateral keeps the lenders stress-free. They would prefer to keep the EMI going smoothly at any time as it maintains a constant inflow of money�loan amounts with hefty interests. But even if EMIs don�t come through, they hold the rights on the collateral to sell it and get back the loan amount. It�s a win-win for them from both sides.
3. Proof of the Borrower�s Creditworthiness
Lenders may also ask for collaterals when your credit score is not up to the mark, and they are not convinced of your creditworthiness. As lenders are very particular about the safety of the funds borrowed, they either rely on a good credit score or resort to a security with a higher value than the loan.�
FAQs on Collateral
Here are some frequently asked questions on Collateral:
Why do lenders use collateral?
Lenders often ask you to pledge an asset against the loan granted so that they can sell the collateral and recover their bad debts.
Do lenders ask for collateral?
Yes, lenders ask for collaterals in the case of a secured loan.
What do you mean by collateral?
A collateral is an asset the borrower owns that acts as a security. This security is auctioned or sold if the borrower stops paying the EMIs, and the lender has no other option to get their funds back.
Why do banks ask for collateral?
Banks ask for collaterals to be assured of receiving back the funds lent even if the borrower fails to do so.
Why is it called collateral?
Collateral literally means �Something that we provide to the lender as a guarantee that we�ll repay the loan.� Similarly, in the case of loans, we mortgage our asset as a promise to repay it within the stipulated time. That�s why the asset pledged is called collateral.
What are some examples of collateral?
Here are three examples of collateral:
- In the case of a home loan, the house acts as collateral.
- When you take out a car loan, the car is collateral.
- You can keep your life insurance policy as collateral for a business loan.
We have reached the end of this blog. We hope your understanding of �all things collateral� just got better. So, now, you�ll know why lenders ask you for collateral if you go for a loan.�
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