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Importance of Collateral

Importance of Collateral

Generally, secured loans offer better terms and clauses than unsecured loans. With secured loans, borrowers can get lower interest rates and longer loan periods, as they can provide collateral, which makes the loan a more secure investment for the lender.

Definition of Collateral

Collateral describes assets or personal estate, land or house that one can utilize to secure a loan. If due to any reason, you default on a loan secured with collateral, the lender can take possession of the collateral. In such an event, once the collateral becomes the property of the lender, he can sell it to compensate for the unreturned borrowed money.

For the Lender

If collateral has been used to take a loan, the lender can seize the property to repay the debt, in case of defaults. However, lenders of unsecured loans have to use adjudication before they can seize property. Furthermore, lenders of unsecured loans cannot take possession of a property that the borrower has used to secure another loan. The lender doesn’t have access to the borrower’s other major assets, apart from the one used for collateral.

Probability of Repayment

When a loan is secured with security, it turns out to be more advantageous for the lender because borrowers wouldn’t want to lose the property they have given as security, so they are less likely to default on the loan. Moreover, if a borrower has multiple debts and is unable to afford his payments, he would prefer to first make payments on the secured loans before he pays unsecured loans and other bills.

For the Borrower

With security or collateral, there is more possibility for the lender to approve the loan, especially if you have bad credit or low income. If you don’t have a major property like a car or a house, lenders may even accept other forms of collateral, such as gold jewelry. As secured loans are usually offered lower interest rates, and the lender may also allow you more time to repay the loan, it is more advisable to use collateral and opt for one.

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 most borrowers is real estate, such as one’s home or land. Aside from being easily available, such properties come with a high value and low depreciation. However, it can also be risky because if the property is confiscated due to default, it cannot be taken back.

         2. Cash secured loan

Cash is another frequently used collateral. 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 recover the borrowed money.

         3. Inventory financing

This involves an inventory that serves as the basis for the release of a loan. Should a default happen, the things listed in the inventory will be offered for sale.

         4. Invoice collateral

Invoices are one of the types of collateral used by small businesses, wherein invoices that are still 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 of its loan.

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