Do you need extra money for a vacation, emergency expense, or any other purchase? The funds in your bank account can provide some coverage, but a personal loan can provide the additional capital you need. You can borrow a few thousand dollars if you need a small loan or over $100,000 for larger commitments. Then, you make monthly payments until you pay off the loan. You can extend the loan to minimize payments or opt for a shorter loan if you want to get out of debt sooner.
If you have already taken out a mortgage or auto loan, you’re used to putting up collateral for a loan. Since collateral is a requirement for many loans, it’s easy to wonder if that requirement extends to personal loans. Of course, the answer depends on what type of personal loan you get.
What Is Collateral?
Collateral is an asset you put on the line in case you can’t make loan payments. The bank, credit union, or online lender can legally take possession of your collateral if you default on the loan. If you are late on one payment, lenders will work with you before this final resort. Even if you miss multiple payments, a lender will not act right away. Lenders usually wait until several months before they take legal action, and you default on the loan. Either way, missing payments will hurt your credit score and increase your fees.
Some people are afraid to put up collateral because they have to give it to the lender if they default on the loan. However, using collateral can be advantageous because it can increase the likelihood of securing a loan and reduce your interest rate. That’s because collateral shifts some of the risk from the lender to the borrower. Lenders reward lower risk with better terms, and this way of business explains why consumers with excellent credit scores often get the best terms.
The Difference Between Secured vs. Unsecured Loans
The type of loan determines if you need collateral. A secured loan requires collateral, which can be a personal asset or a business asset. Some loans have multiple assets that get pledged as collateral instead of a more straightforward mortgage that only uses the acquired property as collateral. Some secured loans have lower interest rates to reflect some of the risk going to the borrower. However, secured loans may represent the only path to financing, especially if you have bad credit or no credit history.
An unsecured personal loan does not require any assets as collateral. You receive the capital immediately and can use it however you desire. If you fall behind on payments, you will rack up fees and damage your credit. However, you won’t be risking an asset. Ignoring an unsecured personal loan can eventually cause you to lose assets if you default on the loan and the lender or a debt collection agency takes you to court. You may have your paychecks garnished until the loan gets paid off. It’s important to stay on top of loan payments regardless of whether you have a secured or unsecured loan. However, an unsecured loan can feel like less weight on your shoulders since you don’t have any collateral involved.
Regardless of which loan you get, you will probably have to go through a hard credit check. This process gives lenders a more accurate understanding of how well you manage financial obligations. This event will drop your credit score by a few points, but it’s relatively easy to recover from this event. You can prequalify for personal loans without the hard credit inquiry to see what rates and terms you can get.
Do Personal Loans Always Require Collateral?
Not every personal loan requires collateral. If you get a secured personal loan, you will have to put up collateral. Most people going with this option want to secure a lower interest rate, borrow more capital, or get financing with a low credit score. Borrowers with good credit may get sufficient interest rates and loan amounts with unsecured personal loans. If you don’t want to put collateral into the loan, you need an unsecured personal loan.
Which Personal Loans Require Collateral?
Secured loans always require collateral. However, these loans may have lower requirements and more competitive rates. You might even get a higher loan amount by putting down more collateral. Even if you use collateral, a lender will still check your credit score and look at your financials to assess if you can afford the monthly payments.
What Can You Use as Collateral for Personal Loans?
Each lender has different rules for what qualifies as collateral, but borrowers have a vast amount of choices:
- Cash and cash equivalents
- Real estate
- Precious metals
- Insurance policy
You can pledge one or several assets to cover the collateral requirement for the personal loan. Lenders will use a percentage of the item’s face value as collateral. While cash gets 100% face value, you may not get the full face value of jewelry or an automobile. Lenders assign a lower face value percentage to assets that are less liquid and depreciate over time. Some assets check both of those boxes, while other assets only fulfill one of those parameters.
It’s also important to avoid assets that already have liens on them. Each asset pledged as collateral has a lien on it. This process happens for every home financed through a mortgage. The lien gives the bank the right to seize the asset if the homeowner defaults on the loan, and it only gets removed when you repay the mortgage debt.
If you have a lien on your home, you can’t go ahead and use that property as collateral for a personal loan. This is because most banks have rules that prevent them from using an asset as collateral if it already has a lien on it. This rule usually applies to homes and automobiles, but if you take out multiple secured personal loans, you may have several assets pledged as collateral.
Borrowers who want to use their homes as collateral may want to consider a home equity loan or home equity line of credit instead. These financial products let you borrow against the equity in your home even if you are currently paying a mortgage.
Are There Personal Loans That Require No Collateral?
You can find personal loans that require no collateral. These loans typically have higher credit score requirements and higher interest rates. Consumers with good credit scores may get competitive rates, but secured loans with collateral usually have lower rates.
You will also need a good debt-to-income ratio to get an unsecured loan. This ratio measures the percentage of income you use to pay off debt. For example, if you pay $2,000/mo in debt and earn $6,000/mo, you have a 33% debt-to-income ratio. That ratio will help you qualify for most loans. Secured loans also have this requirement, but lenders offering unsecured loans may have more challenging requirements to compensate for the extra risk. You will also have to demonstrate a steady income. It’s common for lenders to look at up to two years of your income when deciding on your loan’s maximum amount and interest rate.
Get Credit Without the Need for Collateral
An unsecured loan doesn’t require collateral, but it will require a credit check, something that negatively impacts your credit score. You’ll also need a good credit score to get an unsecured personal loan, and it can take a while for funds to arrive.
Borrowers seeking a quicker path to financing without credit checks or any credit score requirement can get their capital from Grain. The financial app provides users with a line of credit that connects to their debit cards. When you make a payment with your debit card, Grain’s line of credit covers the payment. Then, the funds in your checking account cover the credit line. Nothing different happens financially, but this workaround turns your debit card into a credit-building resource. You also get access to more capital in case you run out of funds in your checking account.
The great thing about lines of credit is that you don’t pay interest on them if you repay them before the grace period. The grace period depends on the issuer, but knowing your window and repaying the line of credit on time can shield you from high costs. Grain lets users enable auto-pay, so they don’t have to worry about missing payments.
If you want to make manual payments, Grain provides insights on when each payment is due. You have 21 days after the statement generation date to pay off the credit line before interest or late fees. If you want to avoid late fees, you can make a minimum payment and then pay the rest of the balance next month.
Thousands of people use Grain, and the app can integrate with over 10,000 banks. Want to learn how Grain can help your finances? You can get started by downloading the Grain mobile app today.