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What is Collateral and How Does it Work?

When you apply for a mortgage or loan you may hear the word “collateral” used by the lender. What is “collateral” and what is its purpose? Let’s look at the use of collateral in loan processing.

When you sign for any loan, you agree that you are offering something to the lender that secures the loan. If you fail to repay the loan for any reason, the lender has the right to take whatever you offered and sell it to help recoup some of their losses. The “something” is the collateral in the loan; if you borrow money for a car, the car is typically the collateral and the lender can repossess it from you if the loan defaults. If you borrow money for a home, that home is the collateral and you can lose it if you fail to repay the mortgage as agreed in the original loan document.

What you are offering is the ability of the lender to prevent a total loss for failure of a loan. A collateral loan provides you and the lender more options than an unsecured loan:

  • Collateral can provide you a better chance of securing a larger loan because the lender has some protection from loss
  • Lenders may offer lower interest rates on secured loans due to the lower risk
  • Lenders have some flexibility in what collateral they will accept

Lenders don’t want to deal with repossession or legal action to gain their collateral in the event you default on a loan since they aren’t generally in the car, home, or other investment ownership business. But don’t assume you can stop making your loan payments because you believe a lender won’t want to bother with repossession. Lenders aren’t in the business of giving money away and they will take action when needed to protect their investment.

It is important to note that offering other types of collateral such as investment portfolios, insurance policies, or valuables and collectibles might be possible with some lenders. However, the lender will typically offer you less in valuation than you might consider acceptable. This provides the lender the cushion they need to recoup their losses if the loan defaults. Don’t take this personally; the lender needs to protect their business position.

Shop Commercial Mortgage uses the equity accumulated in your property to secure their investors’ loans. Therefore the property itself will be secured when you arrange a mortgage or commercial loan with us. The advantage to you is we don’t focus on credit rating, previous bankruptcies or foreclosures, or other barriers to obtaining a loan from a conventional lender. Contact Shop Commercial Mortgage today about our loan services.

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