A collateral loan, meaning a loan backed by an asset as security, is a secured loan that reduces the risk of the lender and helps borrowers secure better interest rates.
Loans are categorized as secured and unsecured. Secured loans require collateral, while unsecured loans don’t need security. Collateral loans are a key type of secured loan. In this article, we’ll explore collateral loans and collateral securities so you can make informed borrowing decisions.
What is a Collateral Loan?
A collateral loan is a secured loan where you can pledge an asset, such as property, gold, or investments as security to secure credit. Unlike unsecured loans, which don’t require collateral, collateral loans often come with lower interest rates and higher borrowing limits because they pose less risk to lenders. However, if you default, the lender can sell your asset to recover the loan amount.
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.
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.
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 it 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 a 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 loans include loans against insurance policies, valuable items, accounts receivables and inventory.
Pros & cons of Collateral Loan
Collateral loans provide a secured way to access funds by pledging an asset as security. However, they also come with certain risks and limitations.
Pros:
- Easier approval: Borrowers with low credit scores can still qualify for financing.
- Lower interest rates: Lenders offer reduced rates since the loan is backed by an asset.
- Higher loan amounts: Collateral increases borrowing capacity compared to unsecured loans.
- Credit score improvement: Timely repayments help build and enhance credit scores.
Cons:
- Asset requirement: Only borrowers with valuable assets can apply for a collateral loan.
- Complex process: It requires more paperwork and verification compared to unsecured loans.
- Risk of asset loss: Defaulting can lead to losing the pledged collateral.
Examples of Collateral Loans
Collateral loans come in various forms, depending on the asset pledged. Here are some common examples:
- Loan against property: You can pledge your residential or commercial property to secure a loan. A loan against property is typically used for business expansion, medical emergencies, or large expenses.
- Loan against securities: You can use investments like shares, bonds, or mutual funds as collateral. This is a great way to access liquidity without selling your holdings.
- Loan against fixed deposit (FD): Banks offer loans against FDs at lower interest rates. This lets you borrow the required funds while keeping your savings intact.
- Machinery loan: Businesses can pledge machinery or equipment to secure funds for expansion, upgrades, or working capital needs.
- Loan against gold: You can pledge your gold ornaments or coins to obtain quick funds for short-term financial needs.
- Auto loan: A car loan is a type of collateral loan where the vehicle itself serves as security until the loan is repaid.
What can be pledged as collateral?
You can pledge various types of assets as collateral to secure a loan. One of the most commonly used options is vehicles and machinery, which are considered movable assets. Since they have resale value, lenders often accept them as security. However, in some cases, you may need to temporarily transfer possession of these assets to obtain the loan.
Gold and other valuables are another popular choice, as gold holds substantial value. Financial institutions typically accept gold coins, bars, and jewellery, while high-value collectables like antiques and fine art may also qualify as collateral. Alternatively, you can also use real estate, including land and property, as collateral due to its high market value. For example, you can use your home or land holdings to access substantial funding.
Additionally, personal investments such as stocks, bonds, and mutual funds can also be pledged as security to get a loan. Even sovereign gold bonds are accepted as collateral by lenders, allowing investors to leverage their financial assets for loans.
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.
How Do I Get Back My Collateral?
Getting your collateral back after repaying a loan is a straightforward process, but it requires a few essential steps:
– Complete loan repayment: Make sure you have fully repaid the loan amount, including interest and any additional fees, as per the agreed terms.
– Lien or claim release: Once the loan is cleared, the lender will remove their legal claim on the asset. For vehicles and real estate, this may involve paperwork to officially lift the lien.
– Collect official documentation: Always obtain written confirmation from the lender stating that the loan is paid in full and the collateral is officially released.
Conclusion
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 or personal loan now!
FAQs
A collateral is an asset pledged to a lender as security for a loan. If the borrower fails to repay, the lender can seize the asset to recover the loan amount.
Yes, property can be used as collateral, but other assets like gold, vehicles, fixed deposits, and investments can also serve as collateral for securing a loan.
Unsecured loans, such as personal loans, student loans, and credit cards, do not require collateral. Lenders approve them based on the borrower’s credit score and repayment ability.
Yes, once the loan is fully repaid, including interest and fees, the lender releases the claim, and you regain full ownership of the pledged asset.
Common synonyms for collateral include security, guarantee, pledge, or surety, as they all refer to assets used to secure a loan.
An asset is anything valuable that a person or company owns, while collateral is an asset specifically pledged as security for a loan. All collateral is an asset, but not all assets are collateral unless used for borrowing.
16 April 2025
8 mins read
Previous Post
