Collateral Loans: How They Work and When to Use One
A collateral loan can help you qualify for a personal loan, get better terms or borrow more money, but it comes with real risk. If you stop making payments or break loan terms, the lender can take the asset you used as collateral.
A collateral loan uses a valuable piece of your property to “back,” or secure, the loan. Because the lender has something valuable it can repossess, collateral loans can be easier to qualify for and offer larger loan amounts.
Mortgages and auto loans are common examples, but this guide focuses on personal loans that use collateral.
- Collateral can help you qualify for a loan, but you risk losing that asset if you can’t repay.
- Different collateral types carry different risks. Losing cash might not impact you the same way as losing your car.
- Breaking loan terms (like dropping required insurance) can lead to repossession, even if you haven’t missed a payment.
Should you use a collateral loan?
A collateral loan, otherwise known as a secured loan, can be risky. You’re putting both your credit and a valuable asset on the line when you borrow. Even so, offering collateral could be a good option for some people, including:
- Borrowers with bad credit who want to boost their approval odds
- Borrowers looking for a lower rate
- Borrowers who need a bigger loan
Choosing the right personal loan collateral
Lenders decide what they will accept as collateral, but cars, savings accounts, investment accounts and permanent home fixtures are the most common for personal loans. Which type of collateral you choose depends on what you have available and your risk tolerance.
In general, the best collateral is the asset you can afford to lose without disrupting your daily life.
| Collateral type | Risk if repossessed | Other considerations | Lenders that accept this collateral |
|---|---|---|---|
| Vehicle | May lose your ability to get to work | Full coverage car insurance usually required, and not all cars qualify | Upgrade, OneMain Financial |
| Savings account | May lose nest egg or emergency fund | Loan amounts are often tied to how much you have saved | First Tech Federal Credit Union, Navy Federal Credit Union |
| Investment account | Will lose potential investment growth | If investments are sold to repay the loan or satisfy the lender, you may owe capital gains taxes | First Tech Federal Credit Union, Navy Federal Credit Union |
| Home fixtures | May lose built-in home fixtures (like cabinetry, light fixtures) | You may need to pay off the loan before selling or refinancing your home | Best Egg, Upgrade |
How collateral affects loan terms
Secured loan rates tend to be lower and credit requirements may be easier to meet because the lender has something of value backing the loan. But the tradeoff is real. If you can’t repay, the lender can repossess your asset.
Unsecured personal loans don’t require collateral, so they are lower risk for the borrower. In return, unsecured loans typically come with higher rates and stricter approval requirements. Your eligibility and annual percentage rates (APRs) are solely based on the lender’s confidence in your ability to repay, based on your income and credit history.
| Secured | Unsecured | |
|---|---|---|
| APR | Lower (collateral lowers the lender’s risk) | Higher (risk is based on credit alone) |
| Risk to you | Asset at risk (lender can repossess if you default) | Missed payments can hurt credit (but no asset risk) |
| Approval requirements | Easier (collateral can help offset credit) | Harder (approval depends more on credit and income) |
| Time for approval decision | Slower (lender may need to assess collateral) | Faster (fewer documents and no asset evaluation) |
Secured vs. unsecured loans: an example
Online lender Best Egg offers both secured and unsecured personal loans. Comparing the two options is an easy way to see how collateral can impact personal loan rates, repayment terms, loan amounts and fees.
| Best Egg unsecured personal loan | Best Egg secured personal loan | |
|---|---|---|
| APR | 6.99% – 35.99% | 5.99% – 29.99% |
| Loan terms | 36 to 60 months | 36 to 84 months |
| Loan amounts | $2,000 – $50,000 | $5,000 – $50,000 |
| Origination fee | 0.99% – 9.99% | 1.49% – 8.99% |
| Collateral | None | Permanent home fixtures |
Best Egg’s secured personal loans have lower APRs, longer terms, a higher minimum loan amount and a higher starting origination fee. The higher origination fee may be confusing since secured loans typically come with better rates. An origination fee is an upfront fee that some lenders charge to cover loan processing. Lenders typically deduct this fee from the loan before sending it to the borrower.
Because it generally takes more work for lenders to process a secured loan application, that typically helps to explain the higher origination fee that’s then worked into the APR you’re offered. All else being equal, lower APRs are still cheaper for borrowers even if fees are higher — but you may need to borrow more to make up for the fee, leading to more debt and overall interest.
When you’re ready to compare secured loan options
Once you’ve decided what type of collateral makes sense, comparing lenders with LendingTree can help you find the right rate and terms. Here’s what to focus on:
- Compare offers from multiple lenders instead of applying one at a time
- See how rates and terms vary based on your credit and collateral
- Choose the option that fits your budget and risk tolerance
What happens to your collateral if you can’t pay?
No one plans on defaulting on a loan. Still, it’s important to understand what can happen to your collateral if you’re unable to pay. While the process varies by lender and the collateral securing the loan, below is a general overview.
You miss loan payments or violate loan terms
Repossession typically begins after missed payments, but it can also happen if you break other terms. Many lenders wait until you’re significantly behind on payments (often 60 to 90 days), but they can act sooner depending on your loan agreement.
Tip from the experts at LendingTree
If you’re using your car as collateral on a personal loan, don’t forget to budget for car insurance.
My time as a car insurance agent showed me that you don’t have to miss payments to have your car repossessed. The lender can also take your car if you stop carrying full coverage insurance. If you’re adding coverage to qualify, make sure you can afford the premiums for the life of the loan. Also, keep a buffer. Car insurance rates can rise over time, especially when inflation is high.
The lender declares the loan in default
After a certain point, the lender will declare the loan “in default.” This means you’ve broken the terms of your agreement, and the lender can demand repayment and begin collection efforts. Along with repossession, the lender may take other actions, like filing a lawsuit to garnish your wages.
The lender repossesses and sells your collateral
Once the lender has your collateral, it may sell it to make up for what you still owe. If the value of your collateral is not enough to cover your remaining debt, you are responsible for making up the difference. This is called a deficiency balance.
Your credit is impacted
A defaulted loan and repossession can significantly damage your credit. This type of activity typically remains on your credit report for up to seven years. This can make it harder to qualify for new credit, and you will likely face higher rates and fees in the future.
Frequently asked questions
Collateral loans usually build credit, but it depends on whether the lender reports payments to the credit bureaus. Most personal loan lenders do, including those that accept collateral. Check the lender’s FAQ section or your loan offer for more information.
The credit score needed for a personal loan varies based on the lender’s eligibility requirements. According to LendingTree data, users who received at least one loan offer had an average credit score of 653. Users who received no offers averaged 598.
Yes, secured loans can make it easier to qualify for a personal loan. Collateral loans can also come with larger loan amounts and lower rates. Lenders tend to have more confidence in collateral loans. You’re more likely to pay the loan back, so you don’t lose your asset. And if the lender does repossess, it can offset some of its losses by selling your collateral.
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