The Most Common Assets Used as Collateral for a Home Loan
If you are in the market for a home, or looking to make updates to your existing home, the first step is often determining how much money you can borrow. Banks will not lend to just anyone, so you will need to have assets to secure your loan and when you do this, your assets become collateral. Collateral is defined by Investopedia as “property or other assets that a borrower offers a lender to secure a loan. The day all the loan is paid off by the borrower is the day the home will no longer be collateral, and the lender won’t have any rights to the asset.” This is a way of allowing the bank to recoup the funds in the event of nonpayment. Traditionally a mortgage is backed by the home you are buying but if you need more financing or have other mitigating circumstances, you can turn to other forms of collateral.
What is a Collateral Home Loan?
A collateral home loan is a mortgage that is backed by an asset that is accepted by your lender. Anyone looking to get a loan from a bank needs to prove that they have the means to pay as well as show collateral that can help the bank recoup money in the event of default. The good news is basically anything a lender is willing to accept as collateral can serve as collateral, although, most lenders are looking for assets that can be easily liquidated for cash. Collateral loans work much like a traditional loan with the same process to apply and receive the funds. The main difference is in a collateral home loan, the lender has the authority to take possession of the collateral you pledge and use it to pay off the mortgage in the event of default. Depending on what you use as collateral, this could make for a tough situation if you find yourself unable to pay.
For this reason, it is especially important to look at all factors when you use collateral to secure a home loan. On the one hand, collateral may help you obtain a loan you might not qualify for otherwise. However, using your assets as collateral does expose you to risks.
Examples of Common Assets Used as Collateral
When your intended purchase is a home, you have a variety of options for what you can put up as collateral or, depending on the lender, leverage the equity you have in your assets, to secure financing from independent sources for a home loan down payment. These can include real estate, life insurance, cars, and stocks & bonds. You will need to assess each of these options separately to determine if they are the right course of action for your situation. Each collateral type has pros and for both the loan transaction at hand as well as long time effects on your financial wellbeing.
You can use real estate to secure a loan in a number of different ways. One of these options is to use the equity in your home as collateral. If you have owned your home for some time, or the market has allowed you to build equity, this can be a good option for collateral. You can also use a house you own outright as collateral on a second home or investment property. Or you can use an investment property as collateral for a primary residence.
Banks will look at real estate collateral favorably as property generally holds its value and would allow them to make back losses more readily. However, using your home as collateral means that defaulting could result in foreclosure. At the same time though, it is one of the most easily available forms of collateral and offers high-value.
Much like other collateral options, you need to own your car or have equity. The one problem with cars is they tend to depreciate quickly so in the scheme of a mortgage, the collateral they offer is relatively small. However, as one of the larger consumer purchases, cars can offer some collateral, but they also come with potential drawbacks. When a lender takes something as collateral it means they get to repossess it if you don’t pay. As you can imagine, having your car repossessed can wreak havoc on your ability to get around. Also, consider that the home itself may still have a lien on it in that scenario. If you are buying a home that is of higher value than what the bank is willing to lend, you may be able to use your car as collateral to make up the difference. While cars are an option banks will entertain, it is less common to use a car as collateral.
Stocks and Bonds
It is not unusual for investors to entertain the idea of using their portfolios as collateral for a loan. And why not? Your portfolio can be a sizeable piece of your overall net worth. However, stocks and bonds are a little more tricky when it comes to securing a loan. This is due to the fact that your portfolio value can fluctuate giving the bank less to cash out. If you use stocks or bond to secure a home loan, a bank has the right to sell off your assets when they see it begin to devalue. any banks will allow you to make up the difference with cash before they sell, but they are under no obligation to tell you when they are selling off the collateral. For this reason, stocks and bonds become a risky option for securing a loan.
The Bottom Line: Should I Use Assets as Collateral for a Home Loan?
Taking out a home loan is a big decision—it takes time and consideration to find the right one for your needs. There are some pros to using collateral for your home loan like bridging a gap in financing and requiring less upfront money and can also lower interest rates. You can however, find yourself in a tough situation if you are suddenly unable to pay your mortgage.
When It Makes Sense to Use Assets as Collateral for a Home Loan
Solid, high value collateral can help many buyers during the loan process. That means that collateral that you own outright can be a boon to your home loan process when considered with caution. Your assets also come in handy when you have less on hand to liquidate for the loan. Bankrate points out that collateral can also work in your favor, “Although the borrower risks forfeiting his property or business assets to the lender, putting up collateral can lead to higher borrowing limits and lower interest rates.”
When it Doesn’t Make Sense to Use Assets as Collateral for a Home Loan
When your options for collateral are on the risky or low-value end, it is important to think carefully before proceeding. Stocks and bonds that are rising now, could plummet tomorrow. When these potential events coincide with an event that makes you unable to pay, you can find yourself losing assets along with the home.
For these reasons, it is critical to take the time to consult with a professional about your collateral and loan options. The right lender will take the time to make sure your choice is the right one for you.
If you would like to learn more about collateral home loans, we encourage you to reach out to our team. We are extremely knowledgeable on loans and are happy to make sure you have everything you need to make an informed decision.
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