There are lots of ways to obtain credit in the modern world. You have mortgages, car loans, and personal loans. You also have credit cards and revolving lines of credit offered by retailers. No matter the type of credit a person is hoping to obtain, it will be either secured or unsecured. All secured loans require collateral. Furthermore, collateral affects different types of loans in different ways.
Collateral is a hard asset that backs up a loan, which is to say that the asset can be seized and sold should the borrower not make scheduled loan payments. Collateral can be just about anything depending on loan type. It just has to be valuable enough to cover the cost of the loan should it go into default.
Collateral for Hard Money
Hard money loans represent the easiest way to understand collateral. If you were a real estate investor looking to buy a new piece of property with a hard money loan, the lender would value the property you want to purchase via appraisal, historical data, and other means. This is something that Salt Lake City-based Actium Partners does all the time.
If the property’s value meets the lender’s requirements, a loan will usually be offered as a percentage of that value. The lender will also place a lien on the property at closing. Should the investor fail to pay off the loan, the lender will seize and sell the property.
Collateral for Bridge Loans
Bridge loans are very similar to hard money loans. They are almost always the domain of investors and commercial borrowers, though mortgage lenders are known to offer bridge loans for residential real estate transactions on a limited basis. Either way, collateral affects bridge loans in the exact same way.
Collateral for Mortgages
A mortgage is another secured loan that is backed by collateral: the house being purchased. Traditional mortgage lenders account for LTVs just like hard money lenders. They also place liens on the properties they fund. However, there is one fundamental difference between hard money and traditional mortgages: the role collateral plays in approval.
Hard money loans are approved and funded almost entirely based on the value of the offered collateral. Hard money lenders do not look at tax returns, credit reports, etc. Mortgage lenders do. Why? Because it is a lot more difficult and costly to foreclose on a borrower’s primary residence.
Mortgage lenders would prefer to avoid foreclosure at all costs. It’s too much hassle for them. So while they look at collateral, they also look at every financial detail of a borrower’s life. All of those other details will affect approval more than the value of the home being purchased.
Collateral for Car Loans
Car loans are very similar to mortgages in terms of collateral. The car being bought is the collateral, and the lender files a lien against the car’s title when a loan is funded. That lien can only be removed after the loan is fully paid. Fail to make your payments and the lender can repossess your car and sell it at auction.
The biggest difference between loan types is how much emphasis lenders place on collateral. Approval for hard money and bridge loans is based almost entirely on collateral. Approval for mortgages, car loans, and other forms of secured commercial lending is based more on a borrower’s financial details.
In every case, collateral can be seized and sold should a loan go into default. That much does not change. Therefore, it is wise to carefully consider one’s ability to repay a secured loan before ever making application.