What is a collateral loan?

Loans broadly fall into two categories. They are unsecured and secured loans. An unsecured loan is released based on the creditworthiness of the borrower and is generally provided to those with high credit scores.

Unsecured loans could be a revolving loan product that contains a credit limit such as a credit card or a term loan, where a lump sum amount is given to the borrower, who repays it in monthly EMIs until the end of the term.

A popular form of unsecured loan is a personal loan that can be availed for various purposes and has no restrictions on the end usage.

They can also be availed for specific purposes like marriage, education, travel, emergency or a loan for debt consolidation, which can be used to pay off existing unsecured debt obligations.

On the other hand, in the secured loans the borrower is required to keep an asset as surety or collateral to borrow money.

Put simply, collateral is an item of value that a lender can seize from a borrower if he or she fails to repay a loan according to the agreed terms. One common example is mortgage loans. Normally, the lender will ask you to provide your home as collateral.

This means that if you fail to meet the repayment terms of your mortgage, the bank has the right to take ownership of your home.  The bank can then sell your home in order to recoup the money that it lent to you.

Assets than can be used as collateral include vehicles, properties, gold, fixed deposits, investments, insurance policies, machinery and receivables.

A loan against securities can also be obtained by pledging shares, mutual fund units and bonds. While a loan against property can be availed for personal or business purposes by pledging residential and commercial properties.

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