What is a Collateral Loan?

A collateral loan is a type of secured loan arrangement between the lender and borrower wherein the borrower pledges assets (collateral) like property, financial securities, etc. to secure a loan. The understanding is that in case the borrower is unable to repay the loan, the lender can recover the amount by getting ownership of the collateral. Such loans enable borrowers to get larger loan amounts for longer tenures, depending on the nature of the collateral pledged. The value of collateral further assists the borrower to negotiate the terms of the loan arrangement. Such negotiation could be to a lower interest rate, higher loan amount, favourable loan tenure etc.

The purpose of the loan could be for personal uses or for business expansion. . Assets such as private / commercial vehicles, Commercial and Residential Property, Investments like fixed deposits, shares, other financial assets, etc., are eligible to become collateral for the loan from the financial institution. Read more to understand a few types of collateral loans.

1. Loan Against Securities

A loan against securities is an extension of an overdraft facility by the financial institutions. The financial assets like shares, bonds etc. act as collateral with the lender, against which the borrower is issued a limit. The borrower can then take short term loans within this limit.

2. Vehicle Loans

No guarantor is required for such a loan since the car itself acts as a security with the lender. A typical car financing arrangement is different from a loan against a commercial vehicle. A car financing arrangement is executed at the time of purchase of the vehicle; the proceeds are purely utilized for the purchase of the vehicle only. The borrower is free to use the vehicle for any purpose. However, commercial vehicles cannot be used for personal use by the borrower, who has to have an existing business to be eligible for the loan.

3. Loan Against Property

A loan against property financing arrangement includes a loan taken from a financial institution with no restriction on its use by the borrower. The existing house property is kept as collateral with the lender as a security against a probable default by the borrower. Whereas, A typical housing loan financing arrangement is to facilitate the purchase or construction of a new home and the proceeds are to be used for that purpose only.

Thus in conclusion, collateral loans can be taken either for the purchase of a particular asset, in which case the lender keeps the ownership of the asset until the loan is repaid; or alternatively, they are taken by borrowers who pledge already owned assets to borrow a large amount of money with a long repayment tenure.