What is a collateral loan?
A collateral loan is when you borrow against an asset you own, such as a property or car. Collateral means something of value that you agree to forfeit if you cannot repay the money you've borrowed.
This type of guarantee reduces the risk for the lender, so securing a loan with collateral could help you to borrow a larger sum of money over a longer term with a lower annual percentage rate (APR).
What can I use as collateral on a loan?
In the UK, lenders will typically only accept your home as collateral, so these types of loan are more often called:
- secured loans
- homeowner loans
- second-charge mortgages
- home equity loans
However, you may find a loan company that accepts other types of security such as vehicles, land, business or agricultural stock.
Do all loans require collateral?
No, they don't. There are two main types of loans, only one of which requires collateral. Here's a summary of both unsecured loans and secured loans.
Unsecured loans
These are loans that banks or online lenders offer that don't require an asset as security. They're often called personal loans.
A typical unsecured loan term is up to 10 years to borrow between £1,000 and £25,000. They usually come with a lower interest rate than a credit card or overdraft. The interest rate is fixed, but you can get loans with flexible repayment terms.
They're a good option if you have a good credit score and regular income.
Secured loans
A secured loan uses your home or property as security for the lender. The equity (the value of your home that you own) is used as collateral, meaning that if you cannot repay the loan, the lender could sell your property to cover the debt.
Secured loans are typically used for borrowing more than £10,000 for up to 30 years, so a secured loan may not be the most suitable option for you if you only want to borrow short-term or a smaller amount of money.
You'll need to carefully consider the pros and cons of a secured loan because your home is at risk of being repossessed if you cannot keep up with repayments.
How do collateral loans work?
Like with any type of loan, the money you borrow must be repaid over an agreed period with added interest. You'll be offered an interest rate and loan terms based on your asset's value and your creditworthiness.
You'll need to complete an application form and provide personal details so the lender can perform affordability and credit checks.
You’ll also need to provide details and documents about the value of your property and how much you owe on your mortgage.
If you're looking for collateral finance - a loan that accepts a vehicle or business assets as collateral, you’ll need to provide supporting evidence that you own the asset.
If your application is successful, you'll need to sign a credit agreement before the money is transferred into your bank account.
How much can you borrow with a collateral loan?
It will depend on how much equity you have in your home and how much you can realistically afford to repay each month.
You can typically borrow anything between £10,000 and £500,000 if you have the equity in your home to cover the cost - but this will vary between loan providers.
How long do you have to repay a collateral loan?
The minimum term for repaying a secured loan is normally three years and the maximum term is up to 35 years, but this will vary between lenders.
Think carefully about how long you want to repay the loan for, because the longer it takes to repay the loan, the more it will cost you overall.
How do I get a collateral loan?
You can apply for a collateral loan directly with your bank or an online lender.
Like with all loans, the provider will perform affordability and credit checks on your financial background and current circumstances.
You'll need to complete an application form and supply supporting documents.
The information you'll need to provide depends on the type of collateral loan you’re seeking, but it’s a good idea to be prepared to provide documents like:
- Your proof of identity, e.g. your passport or driving licence
- Evidence of your current or past addresses
- Your income and expenditure including any current credit cards or loans
- Your mortgage statement if you have one
- Your vehicle log books, ownership certificates etc if you're using a vehicle as collateral
If you are applying for a secured loan against the value of your home or property, you will need to have your house valued and legal searches may need to take place, which you’ll need to pay for.
The loan terms and the interest rate you're offered depend on your credit history and how much of a risk you present to the lender.
What are the pros and cons of collateral loans?
If you own property or qualify for collateral finance, then a collateral loan could be a good borrowing option, but there are pros and cons to consider.
Collateral loan interest rates are often lower than personal loans, credit cards or overdrafts and it’s an option worth considering if your credit score is poor; however, there are risks involved.
Put simply, If you cannot make repayments on your collateral loan, your house or valued possession could be seized and sold.
Here are some factors to help you decide whether a collateral loan is right for you.
- You can borrow more significant amounts of money, up to £500,000 dependent on the value of your assets
- You can stretch out repayments over a longer term, up to 35 years
- They can be easier to get approved for than a personal loan because you're less of a risk to the lender
- If you have a poor credit score or unconventional financial circumstances, you may get a more favourable interest rate if you offer collateral as security to your loan provider
- If you default on your loan, the lender can repossess your home or asset to recover the money you owe
- Extra charges, legal and arrangement fees can be high
- Some loans have variable interest rates, so your repayments could increase
- If you want to pay off your loan early, you may have to pay an early repayment fee
- You could damage your credit score if you miss or regularly make late payments
What are the alternatives to a collateral loan?
Home improvement loans
Some lenders offer large unsecured loans specifically for home improvements. You can borrow up to £25,000 and pay it back over a set period at a favourable rate. You will need a good credit rating to get approval for this type of unsecured loan.
Personal loans
A personal loan is a standard loan from a bank, building society or lender. You do not need to provide collateral and repayment terms tend to be more flexible. However, if you’re looking to borrow a large amount of money, this type of loan could be costly and mean higher monthly repayments.
Remortgaging
An alternative to taking out a separate loan, is to remortgage. You'll need enough equity in your home to release the funds and upfront fees could be high. Bear in mind you'll be extending your mortgage term, so you will end up paying interest on your mortgage for longer.
Debt consolidation loans
If you're seeking a secured loan to pay off multiple debts, this loan allows you to borrow a set amount to pay off multiple debts, e.g. credit cards, store cards, and overdrafts, which you then pay back with one monthly payment. If you’re having trouble keeping track of what you owe, this can be a helpful way to gain control over your debts and build your credit score.
Collateral loans FAQs
You may qualify for a collateral loan if you have bad credit, and equity in your home. It could be easier than getting a personal loan because secured loan providers have a backup if you’re unable to repay what you borrow.
However, the lender will still need to assess your financial suitability, and your approval chance depends on the risk the lender is prepared to take.
Whilst using collateral to secure your loan could give you a better chance of success, the loan will be more expensive if you have a bad credit rating.
If you are asset-rich but cash poor, a collateral loan is worth considering if you need a large sum of money to build an extension on your home or invest in your business for example.
A collateral loan could be a good option if you're confident of adding value to your existing home or assets using the money you borrow, and you can comfortably afford the repayments on the loan. However, your home is at risk if you cannot make the repayments.
Loan providers ask for collateral to guarantee that the money they lend gets repaid.
Collateral reduces the likelihood of you failing to repay the loan and provides the lender with an asset to sell to recoup any losses should you default on your loan.
By providing your home or a valuable asset as security against borrowed money, you are deemed less of a risk to a lender.
It takes longer to be approved for collateral finance than a personal loan because of the extra checks and legal processes needed.
Whilst you may get a quick decision in principle, carrying out valuations, legal and credit checks will take longer. You can typically expect to wait around 3-4 weeks for funds to be released into your account.