What is Collateral

30 November 2020

Collateral is an asset or property that an individual or entity offers to a lender as security for a loan. It is used as a way to obtain a loan, acting as a protection against potential loss for the lender should the borrower default in his payments. In such an event, the collateral becomes the property of the lender to compensate for the unreturned borrowed money. For example, if a person wants to take out a loan from the bank, he may use his car or the title of a piece of property as collateral. If he fails to repay the loan, the collateral may be seized by the bank, based on the two parties’ agreement. If the borrower has finished paying back his loan, then the collateral is returned to his possession.


Types of Collateral

In order to be able to take out a loan successfully, every business owner or individual should know the different types of collateral that can be used when borrowing.


1. Real estate

The most common type of collateral used by borrowers is real estate, such as one’s home or a parcel of land. Such properties come with a high value and low depreciation. However, it can also be risky because if the property is sequestered due to a default, it cannot any longer be taken back.


2. Cash secured loan

Cash is another common type of collateral because it works very simply. An individual can take a loan from the bank where he maintains active accounts, and in the event of a default, the bank can liquidate his accounts in order to recoup the borrowed money.


3. Inventory financing

This involves inventory that serves as the collateral for a loan. Should a default happen, the items listed in the inventory can be sold by the lender to recoup its loss.


4. Invoice collateral

Invoices are one of the types of collateral used by small businesses, wherein invoices to customers of the business that are still outstanding – unpaid – are used as collateral.


5. Blanket liens

This involves the use of a lien, which is a legal claim allowing a lender to dispose of the assets of a business that is in default on a loan.


Borrowing without Collateral

Not all loans require collateral, especially if the borrower doesn’t have any property to offer. In such a case, there are several ways to borrow money, including: 


1. Unsecured loans

From the name itself, unsecured loans don’t give the lender any form of assurance or protection that the money will be returned. However, they usually involve relatively smaller amounts than what might be loaned against collateral. Examples of unsecured loans include credit card debts.


2. Online loans

With the advancement of technology, there are many more ways to get a loan. In fact, people can now obtain online loans that don’t require collateral and are often approved quickly. After filling out an application form, the lender will let the applicant know if he or she is approved, how much the loan amount is, the interest rate, and how the payments are supposed to be made. 


3. Using a co-maker or co-signer

These types of loans don’t require property for collateral. Instead, another individual besides the borrower co-signs the loan. If the borrower defaults, the co-signer is obliged to pay the loan. Lenders prefer co-signers with a higher credit rating than the borrower. A co-signed loan is often one way an individual without established credit can begin to establish a credit history.


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