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If you are looking for a personal loan, your lender might ask you to put down collateral. This precaution is taken to minimize risk. If you cannot pay the loan, the lenders will seize the collateral.

Before applying for a loan, you need to understand the options available to you. Each one offers different perks and provides you ease with the repayment plan. Let’s talk in detail about this:

What Is Collateral?

Collateral refers to an asset or a property that the borrower offers to the lender as security. Hence, small loans are often referred to as secured loans.

When you are applying for a mortgage, the house itself is the collateral. For example, let’s say you are buying a house. You pay a 20% down payment to get favourable interest rate terms. Since the house is appraised at a very high value, the lender asks you to use the house as collateral. After a year, you are unable to make the monthly payments. Two defaults later, the lender seizes the house. The loan payments are then completed by auctioning the house.

This doesn’t mean that there are no benefits to getting a secured loan. You are probably wondering why not get an unsecured loan instead, right? The major difference between a secured and unsecured loan is that the former offers you a small loan amount, up to $5,000, and the latter offers $15,000.

So, it makes sense to go for the latter. However, the loan amount should not be the only deciding factor. Before discussing the pros and cons of using your home as collateral, why not discuss the types of collaterals first?

Types of Collateral

Real Estate

The most common collateral that the lenders ask for is real estate. It can either be a house or land because these properties have low depreciation and high value. Putting up your house as collateral can be a little risky because you can no longer take it back if the property is confiscated due to defaulting on loan payments.

Cash Secure Load

This type of collateral asks for your savings account. You need to maintain an active account to use cash as collateral. If you default on the payments, the bank liquidates your accounts to cover the remaining amount.

Car

A car is also an expensive asset that can be used as collateral. The bank sells the car to make up for the default payments, and the funds are divided accordingly.

Pros and Cons of Using a Home as Collateral

Pros

High Chances of Approval

One of the biggest benefits of getting a secured loan is that your chances of getting approved for the loan increase. Even if your credit score is not high, you will be able to make up for it by using something valuable you have. As a result, if you find yourself in a difficult situation, you will have a way out.

Low Interest Rates

You can get a great deal on loans with ideal interest rates and repayment terms with a high credit score. Without it, you can use security to negotiate interest rates.

More Wiggle Room

With collateral, you can negotiate the repayment terms for the monthly payments to fit into your budget. For example, by shortening the loan repayment time, your overall cost will be lower, and by extending it, you will be able to afford smaller monthly payments.

Cons

Repossession

One of the scariest cons of using your home as collateral is that your property will be seized if you default on the payments. If its sale does not cover the total cost, you will be forced to auction your car and expensive items. Even though you might have a plan to repay the loan on time, life happens. Make sure that you have a foolproof plan, so you don’t end up on the curb.

Overspending

Since you are using your home as collateral, you will be tempted to take out a large loan. Remember: the more you borrow, the more you will have to pay back. If you are using the loan for an investment, make sure that it promises a reasonable ROI.

Long Term

Depending on the amount of money you are borrowing, you will be tempted to opt for longer terms. Longer terms might sound advantageous because your monthly payments will be low, but it translates to more interest payments over the years.

Using your home as collateral is a great idea, only if you have complete control over your financials. If you plan to take out a secured loan, make sure you can afford the monthly payments along with your personal and fixed expenses.