Personal loans are among the most flexible and common loans that lenders issue. The money you borrow can be used for nearly anything, and qualifying is relatively easy. Although personal loans don’t usually require collateral, there are some situations where collateral may be beneficial.
There are also many different things you can use as collateral. This flexibility may help you get the money you need. Read on to find out what can be used as collateral for a personal loan.
What Is Collateral and How Does it Work?
When borrowing money, collateral is an asset that you allow your lender to hold as protection in case you default on your loan. Default means you stop making payments as agreed in your loan terms. If you don’t repay the loan as promised, your lender will sell the asset to recover the money you borrowed.
In some cases, the item that you purchase with the money you borrow can serve as collateral. For example, the car you buy when you take out an auto loan. Other forms of collateral are typically not required when you buy a car because the car itself serves as the collateral. If you don’t repay your car loan, the lender will repossess the car and sell it.
Secured vs. Unsecured Personal Loans
There are two different kinds of personal loans—secured and unsecured.
- If a loan is secured, it means that it is backed with collateral.
- If a loan is unsecured, it means no collateral is needed.
Personal loans typically do not require collateral. If you qualify for an unsecured personal loan, you simply promise to repay the money on time. Unsecured loans are sometimes called Signature Loans because only your signature is needed, not collateral.
When Do You Need a Secured Loan?
There are some situations where collateral may be necessary or beneficial when you take out your personal loan. Your lender will have certain requirements to qualify for a personal loan, including your credit score and debt-to-income (DTI) ratio. Your lender will also consider how much you want to borrow.
If you do not meet the qualifying criteria or want to borrow a larger amount than your lender is offering, then you may need to take out a secured personal loan and provide collateral.
Collateral You Can Use for a Personal Loan
Different lenders may have various ideas about what can be used as collateral for a personal loan. The following are types of collateral that may be used to secure a personal loan:
Savings Balance or Cash Deposit
The most common type of personal loan collateral is the funds you have in a savings or certificate account, often with the same financial institution that is issuing you the personal loan.
You can’t use your funds while you’re repaying the loan, but you get your money back when you have completed your loan term. If you have no savings, you may make a cash deposit for the amount you wish to borrow.
The car you buy is always used as collateral for your auto loan and vehicles are commonly used as collateral for personal loans, too. Any of these vehicles may serve as collateral:
- Car or truck,
- Boat or Jet Ski
- RV or motorcycle
- Airplane or something else
The amount that you can borrow using your home as collateral will depend on how much home equity you have. Equity is the market value of your home less the remaining balance of your mortgage. You could secure a personal loan with your home, or take out a home equity loan that is built for this purpose.
If you collect something of value, it may serve as collateral for your personal loan. Collectibles are things you buy and hold with the expectation that they will increase in value over time. Examples include:
- Fine art
- Comic books
- Sports memorabilia
Precious Metals and Gems
These are valuable because they tend to hold value well over time. Examples include:
- Gold, silver, platinum metals
- Diamonds, sapphires, emeralds gemstones
- Coins, bullion, or jewelry
Certain investments may be accepted as collateral though your lender may limit you to investments that can be easily liquidated. Examples include:
- Stocks and bonds
- Life insurance policies
- Money market deposits
- Certificates of deposit (CDs)
The Pros of Collateral on Personal Loans
Putting down collateral when you apply for a personal loan may help you in several ways. It could help you save money on interest, let you borrow a higher amount, or allow you to qualify for a loan with a lower credit score.
Get a Lower Interest Rate
Although personal loan rates are not usually very high, you may get an even lower interest rate if you get a secured loan. Loans that are backed with collateral are considered low-risk loans, and a lender may reward a borrower who is low-risk with a better interest rate.
When you apply for a loan, your lender will evaluate your credit score, income, and ability to repay the money. The lender may then approve you to borrow up to a certain amount. If you want to borrow more than the approved amount, you will need to back the loan with collateral.
Borrow With a Lower Credit Score
If you need a higher credit score than your current score to qualify for a personal loan, your lender may approve your loan application if you provide collateral. This may allow you to borrow the money you need without worrying about delays while you improve your credit.
Boost Your Credit Score
An important benefit of qualifying for a personal loan with a low credit score is that it may help to improve your score. The monthly loan payments you make will be reported to the credit reporting bureaus. As long as your payments are made on time, they will help your score.
Can Be Tax Deductible When Used for Certain Purposes
The interest on personal loans is not usually tax deductible because the funds are often used for purposes that the IRS does not deem worthy of tax deduction, like a vacation. But the interest may be tax deductible if you can prove you used the funds for:
- Certain business expenses
- Qualified higher education expenses
- Taxable investments
The Cons of Collateral on Personal Loans
There are two important negatives of using collateral for a personal loan that you should consider before you apply. Depending on your situation, they may outweigh the positives in some cases.
You Risk Losing Your Collateral
If you put your car up as collateral for a personal loan, for example, and then default on the loan, your car will most likely be repossessed and sold. This could leave you without a vehicle to commute to work and other places. If you take out a personal loan that is backed with collateral, it’s important to make all of your payments on time so that you don’t lose your asset.
You Can Only Borrow the Value of Your Collateral
The amount you can borrow with a personal loan that is backed with collateral is directly related to the value of the collateral. If your collateral is valued at $5,000, for example, your lender may limit the amount you can borrow to $5,000 or less.
Personal Loans with Atlantic Financial Federal Credit Union
Now that you know what collateral can be used for a personal loan, you may be wondering whether or not you need to provide an asset to get your loan. Atlantic Financial Federal Credit Union has the answer.
We offer a personal loan with a competitive interest rate and flexible terms. Our loans don’t require any collateral and there’s no application fee. Click the link below to learn more about our personal loans. You can easily apply online or estimate your monthly payments with our online loan calculator.