When considering a loan, one of the most important decisions you will need to make is whether to secure it with collateral. A loan with collateral (or "lån med sikkerhet" in Norwegian) refers to any loan where you put an item up as security - something the lender can take if you do not pay back the loan.
But why does this matter so much, and which options should you choose? Security can make a big difference no matter what kind of loan you are looking for, so it is important to consider your options carefully.
The Basics of Security in Loans
When you take out a loan with collateral, you are essentially giving the lender a form of insurance. This means that if you fail to repay the loan as agreed, the lender has the right to seize the collateral to recover the money.
In other words, you are telling them that they can take that item if you break your promise to repay the loan. If you do not repay it - or only repay part of it - then they have a legal right to repossess that item to get their money back.
Collateral can take various forms. It might be something tangible, like a car or a house, or something financial, like a savings account or investments. The value of the collateral often needs to be equal to or exceed the amount of the loan so that the lender always makes a profit.
Why Is Collateral Good for Lenders?
Collateral serves as a safety net for the lender. If a loan has no security, then customers can refuse to pay it back, and this will usually cause an entire legal battle - and this does not actually guarantee that the lender will get their money back.
For example, if somebody takes out a loan and then simply stops repaying it, it takes time and effort to sue them for the money. Beyond that, if they have no money to repay their debts, then it takes some complex legal proceedings to split up their assets (property) in a way that pays the debts off.
This can be awkward, expensive, incredibly time-consuming, and sometimes even impossible. Some situations (like declaring for bankruptcy without having any assets worth selling off) can mean that the lenders are never really able to get their money back.
Security guarantees that there is an asset they can take if the loan does not get paid off, one that will (usually) cover the loan’s entire value. Since the borrower has marked that property as collateral, claiming it does not involve major legal hurdles.
Why is Collateral Good for Borrowers?
For borrowers, securing a loan with collateral offers several advantages. Since the lender's risk is reduced if you apply for a loan with collateral, you can often get better interest rates and terms than if you went for an unsecured loan.
In addition, having collateral can make it easier for borrowers with less-than-perfect credit to secure a loan. If you have a bad credit score but can put up some collateral worth the same value as the loan, lenders have much less to worry about, so they usually give you better loan options.
Overall, collateral leads to better loans in exchange for you taking on some extra risk - but if you are able to pay the loan back anyway, then the benefits of collateral just make it easier. You might risk losing your car, but your interest rates will also be lower, meaning it is easier to pay the loan off.
What Are The Downsides of Collateral?
While security has no downside for lenders, it can definitely impact borrowers if they are not careful. The most significant risk is the possibility of losing the asset you have put up as collateral.
If you default on your loan - meaning you fail to make the required payments - the lender has the legal right to take possession of your collateral. This can result in the loss of valuable property, such as your home or car if you are not handling the loan well.
Another downside is the added pressure that comes with knowing your assets are on the line. Knowing that a missed payment could result in losing your collateral can create a great deal of stress.
The process of securing a loan with collateral can sometimes be more complex and time-consuming than obtaining an unsecured loan. This means more paperwork and a longer approval time, especially if you are using multiple items as collateral.
Types of Loans with Collateral
Most types of loans can be obtained with collateral, which can massively change the terms, benefits, and risks you get with each loan you take out. Some of the most common types include mortgage loans, auto loans, and secured personal loans.
While many of them work just like any other collateral loan would, others are set up to mark the item that you are purchasing as collateral. This means that you lose what you were buying with the loan if you fail to pay it back.
Mortgage Loans
A mortgage loan is one of the most common forms of secured loans. In this case, the property you are buying (usually a house or an apartment) serves as the collateral.
If you fail to keep up with the mortgage payments, the lender has the right to foreclose on the property, meaning they can take ownership and sell it to recover the debt. Mortgage loans typically come with lower interest rates compared to unsecured loans because they are secured by valuable real estate.
However, the stakes are higher with security, since defaulting on your mortgage could result in the loss of your home. This makes it even more important to properly manage the monthly payments and other associated costs of the loan itself.
Auto Loans
Auto loans work similarly to mortgage loans, except the collateral in this case is the vehicle you are purchasing. The lender holds the title to the car until the loan is fully repaid. If you default on the loan, the lender can repossess the car to recover the outstanding balance.
Like mortgage loans, auto loans usually have lower interest rates because they are secured. Again, if you fail to pay the loan, you lose access to the vehicle - which means that you need to be careful with how you are handling repayments.
Secured Personal Loans
A secured personal loan can be taken out for various reasons, such as debt consolidation, home improvements, or unexpected expenses. It is not quite an all-purpose loan, but it can cover a wide range of costs in the short to mid-term.
With a secured personal loan, you can use assets such as savings accounts, investments, or other valuable property as collateral. The terms of these loans can vary significantly depending on the lender and the type of collateral you offer.
Secured personal loans often come with better interest rates than unsecured personal loans, making them an attractive option for borrowers who need access to funds and are willing to use their assets as security. However, as with other types of secured loans, the risk of losing your collateral if you default is a significant consideration.
Choosing the Right Collateral
When deciding to take out a loan with collateral, choosing the right collateral is crucial. The value, type, and liquidity of the asset you offer can all influence the terms of your loan and the level of risk you are taking on.
Value of the Collateral
The value of your collateral is one of the most important factors in a secured loan. The lender will usually require that the collateral be worth at least as much as the loan amount, allowing them to recover the entire loan’s value if you fail to pay it back.
In some cases, you might be able to use multiple assets as collateral if a single asset does not cover the loan amount. However, this increases the complexity of the loan and the risk of losing multiple assets if you can’t keep up with the payments.
Type of Collateral
Different types of collateral may be more or less attractive to lenders depending on their liquidity and stability. Real estate is often considered one of the best forms of collateral because of its high value and relatively stable market. Vehicles are also commonly used for the same reason.
Financial assets like savings accounts, certificates of deposit (CDs), and stocks can also be used as collateral. However, using financial assets as collateral means you will not have access to those funds for the duration of the loan.
Liquidity of the Collateral
Liquidity refers to how quickly and easily an asset can be converted into cash. Highly liquid assets, such as stocks or savings accounts, are often more desirable as collateral because they can be quickly sold to recover the loan amount.
Real estate, while valuable, is less liquid because it can take time to sell a property and turn it into cash. The more liquid the asset, the more favorable the loan terms are likely to be, because the lender does not need to waste as much time to get their money back.
What Else Should You Know?
There are plenty of resources out there covering collateral - how it works, what it is meant for, and how to choose the right secured loan for your situation. Sites like https://www.billigeforbrukslån.no/lån-med-sikkerhet can be great for finding the advice you need if you are not sure what to do next.
Remember to properly research anything you do not understand, and try to be careful with even small loans. You never want to put your property in unnecessary risk because you did not read the loan terms carefully enough.
