Posted by If you are looking for a loan to fund your personal or business needs, you might have encountered the term ‘collateral loan’. But what exactly is a collateral loan, and how does it work? Here, we will answer these questions and more and help you understand everything you need to know about collateral loans in India.
What is a collateral loan?
A collateral loan is another name for secured borrowing that requires you to pledge an asset as security to borrow money from a lender. The asset, called collateral, acts as a guarantee for the lender that you will repay the loan. If you fail to do so, the lender has the right to seize and sell the collateral to recover their money.
The amount of money you can borrow depends on the value of the collateral. Usually, lenders offer up to 60-80% of the market value of the collateral as the loan amount. The interest rate on a collateral loan is also lower than that of an unsecured loan, as the risk for the lender is reduced.
What are the benefits of a collateral loan?
A collateral loan has several advantages over an unsecured loan, such as:
- Higher loan amount: You can get a larger loan amount with a collateral loan than with an unsecured loan, as the value of the collateral determines the borrowing limit.
- Lower borrowing cost: You can enjoy a lower interest rate with a collateral loan than an unsecured loan, as the lender has less risk of losing money.
- Longer repayment tenure: You can choose a longer repayment tenure with a collateral loan than an unsecured loan. The reason is that the sum involved here is usually higher, and the lender has more security and flexibility.
- Easier approval: You can get approved for a collateral loan more easily, as your credit score and income are not the only factors that matter. Your collateral acts as an assurance for the lender that you will repay the loan.
What are the drawbacks of a collateral loan?
A collateral loan also has some disadvantages that you should be aware of, such as:
- You may lose the asset if they fail to repay the loan on time. This can hurt your financial situation and credit score.
- The loan disbursement process can be more complicated than for an unsecured loan. The lender has to value the asset and verify its ownership and legality. This may require additional documents and fees and take longer time.
- The loan amount may not match the value of the asset. The lender may offer a lower loan-to-value ratio, which means you will get less money than the actual worth of the asset.
- You may face difficulties selling or transferring the asset while the loan is active. You may need the lender’s consent or pay off the loan before you dispose of the asset.
What can be used as collateral for a loan?
Depending on the lender’s policies and preferences, you can use various types of assets as collateral for a loan. Some common examples of assets that can be used as collateral are:
- Property: You can use your residential or commercial property, such as a house, flat, shop, office, etc., as collateral for a loan. Property is one of lenders’ most preferred forms of collateral, as it has high value and liquidity. One of the most popular examples of this kind of loan is a home loan, which can be classified into plot plus construction, renovation, and home repair loans.
- Vehicle: You can use your private or commercial vehicle, such as a car, bike, or truck, as collateral for a loan. The vehicle is another popular form of collateral by lenders, as it has moderate value and resale potential. Two and four-wheeler loans are the most common example of them.
- Gold: You can use your gold ornaments, coins, bars, etc., as collateral for a loan. Gold is one of the oldest and most trusted forms of collateral by lenders, as it has high value and stability.
- Investments: You can use your financial investments, such as fixed deposits, bonds, mutual funds, shares, etc., as collateral for a loan. Some lenders also accept investments as collateral, as they have variable value and liquidity.
Conclusion
In a collateral loan, you provide an asset as security to the lender in exchange for borrowing money. It has several benefits, such as higher loan amounts, lower interest rates, longer repayment tenure, and easier approval.
However, it also has some drawbacks, such as the risk of losing the asset, reduced ownership, and additional costs. You can use various types of assets as collateral for a loan, such as property, vehicle, gold, or investments. You can also use a collateral loan for home repairs, but you should be careful about repaying it on time and completing your project within one year.