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Key takeout
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Collateral is what supports or secures the loan and reduces risk to the lender.
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When using a mortgage, collateral is usually a home purchased by the borrower using the mortgage.
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If you are unable to pay off your mortgage, your lender will grab your collateral by seizing your home.
What is mortgage collateral?
Collateral refers to assets that the borrower provides as a guarantee of a loan or obligation. For mortgages or trust deeds used only in some states, the collateral is mostly the property you purchase on a loan.
How does mortgage collateral work?
Before it approves your mortgage, your lender will order a home valuation to ensure that you are worth the suggestion to pay it. If the home is valued less than the purchase price, the lender can deny the mortgage because the collateral does not guarantee the loan completely.
On the other side of things, if you don’t pay off your mortgage and can’t enter into a relief agreement with the lender, the lender can seize the home and you will lose your collateral.
Examples of collateral in the mortgage process
- Buy a house: When you buy a home with a mortgage, the home serves as collateral for the loan. If you miss a certain number of loan payments (usually 3-6 months of payments), the loan default will be considered. At this point, the lender can seize and retrieve the collateral.
- Home Equity Credit (HELOC) or Home Equity Loan: You can use stocks or ownership shares. You have it in your home as collateral for a HELOC or home equity loan. There are several differences between HELOC and home equity loans, but they share important similarities. You have your house on the line as collateral.
- Start your own business: Some entrepreneurs use their homes as collateral to secure small business loans.
The difference between collateral and mortgage
You can often hear the terms “collateral” and “mortgage” used in the same sentence or similar context, but it’s important to understand the differences.
A mortgage is a type of loan that funds the purchase of real estate. Collateral is the assets that provide loan assistance, that is, loans of all kinds.
You almost always need collateral to get a mortgage, and that collateral is almost always the real estate you are buying on a loan. Think of it as a mortgage as a debt and a collateral as a mortgage. And it’s a demonstration of how serious you are about paying that debt.
Other types of collateral loans
Collateral applies not only to mortgages but also to all types of secured loans. Collateral doesn’t necessarily have to be property either. Some lenders can have borrowers use a savings account or certificate of deposit as collateral. If you don’t pay back the money you borrow, the lender can get cash from your account instead.
- Automatic loan: With a car loan, a car is the collateral that protects your loan. If payment is not possible, the car will be reclaimed.
- Protected personal loans: These loans use assets such as your home, cash account, and car as collateral for your loan. They usually have more lenient eligibility requirements than unsecured personal loans, but may have lower borrowing restrictions.
- Secure Credit Cards: A secure credit card is a card that requires a security deposit. Normally, the credit limit on a card is equal to the size of the deposit. In general, secure cards are used to build or repair borrower credits. Issuers can refund deposits and upgrade their cards to traditional, unsecured versions if they demonstrate responsible use over a certain period of time.
- Securities or Portfolio Credit Line: Use investments in securities companies as collateral for revolving credit lines with a variety of interest rates. You will pay back on your own schedule. If you are against the value of your account, and your holdings drops, you often have to come up with cash to cover some of your debt.
Additional Reports by Andrew Dehan