Should You Use Collateral When Borrowing?

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Life throws a wrench in your plans — a nail punctures your tire, you fracture your wrist playing pickleball, or your cat needs medication to fight off a urinary infection. If these unexpected auto repairs, medical expenses, and prescriptions take money you don’t have, you do what countless of others have done before you: you look into borrowing money.

When it comes time to apply, you have a lot of choices ahead of you. But perhaps the biggest decision is whether to use collateral.

In the world of finances, you have the option of borrowing a secured or unsecured personal loan. So, how do secured and unsecured loans differ and how do they relate to collateral? Keep scrolling to find out.

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Secured Vs. Unsecured Personal Loans Online

Most loans fall into one of two major categories.

On the one side, you have secured loans — these require collateral for you to qualify.

On the other side, you have unsecured loans. You don’t need to have collateral to qualify for unsecured personal loans. They use a different set of criteria, as you’ll learn below.

What is Collateral?

Collateral is something valuable that you own that provides insurance for the loan you want to take out. An asset can make you look less risky as a borrower, as lenders can technically claim your collateral as payment if you fail to repay an secured personal loan.

Many secured loans tend to use the asset you’re borrowing money for as collateral. For example, in a mortgage, your home is a form of collateral. When you take out a car loan or financing, the vehicle is your collateral.

However, you can use a wide variety of items of value, as you can see below:

Antiques and collectibles
Cash savings
Fine art
Future paychecks
Gold and other precious metals
Investment account (bonds, mutual funds, stocks)
Jewelry
Property (boat, real estate, vehicle)

Why Would You Provide Collateral?

In some cases, you have no choice. The conditions of a mortgage make it necessary to use your home as collateral. The same goes for car financing. The financing company may take back your car if you fail to pay your bills in a timely fashion.

You have more agency when it comes personal loans. You can choose to borrow secured loans over other options that don’t require collateral.

So, why would you risk your valuable belonging to qualify for a loan?

Generally speaking, collateral shores up your application. Your asset ensures your lender will receive some form of payment, even if your default on your payments. With that security in hand, a lender may lower rates and offer more favorable terms on their secured personal loans. You may qualify for these more favorable rates and terms, even if your credit score isn’t perfect.

How Do You Qualify Without Collateral?

If you remove collateral off the table, how do lenders assess the risk you pose to their business? They can’t just take a borrower’s word that they will pay them back. Legitimate online loan companies have to run a background check to help them determine your eligibility or creditworthiness.

This background check may include looking at your credit score, pay schedule, employment history, and debt-to-income ratio. Each lender has a unique process, so you may not have to provide the same information if you apply with multiple financial institutions.

A thorough background check is often a normal part of borrowing, even if you have collateral. It helps lenders ensure you are who you say you are, while also giving insights into your past borrowing behavior.

Regardless of where you apply, you may pay more for a loan this way because you won’t have an asset backing your application. Your credit score may play a larger role in what you qualify for, which means a low score could increase your rates or lower your borrowing amount. That said, you can still find installment loans for bad credit online.

Should You Go the Secured or Unsecured Route?

Like many things in personal finances, this choice is personal! It’s up to you whether you want to put an asset on the line. Collateral can be a good way to clinch better rates and terms. However, it’s important to understand the risks. While no one enters a loan agreement thinking they’ll default, things happen. If you choose a secured option, you could lose your asset as a result.