How Collateral can Affect your Loan Rate

Many factors can influence the rates you can negotiate on a loan. One of the most heavily weighted factors is whether you have any equity or other personal property which can secure your loan. Once this property has been committed to securing your loan, it is known as collateral.

Collateral serves as your pledge to repay a loan or other form of credit. The form of the collateral must be acceptable to both you and the lender. If you fail to repay the loan under the agreed terms and the loan goes into default, the collateral then belongs to the lender. Loans which are secured by collateral are sometimes called secured loans.

Securing a loan by pledging collateral usually results in larger loans at lower interest rates than unsecured loans. Many types of loans might not even be offered without collateral.

The value of the collateral you will need to reduce your loan rate is determined by the lender. Usually the more collateral you can bring to the table, the lower will be your rate.

In most cases, the value of the collateral required for a loan will be greater than the value of the loan. This is by design, since the purpose of the collateral is to cover the full value of the loan regardless of future fluctuations in its value. Other factors influencing the amount of collateral required include the risk of the loan and the cost of liquidating the collateral if you default on your loan. Other liens against the collateral are subtracted from its value for the purpose of negotiating interest rates on the current loan.

The major negative of using collateral to secure a loan is that you will lose the collateral if you default on the loan. If the value of the collateral is not sufficient to cover the loan, you may additionally have to make up any deficiency. A few types of loans are covered by anti-deficiency laws, which prohibit the creditor from collecting a deficiency. This kind of debt is called a non-recourse debt. Non-recourse debts are most common among mortgages for the primary dwelling.

One of the most common ways to reduce loan rates by using collateral is when debt is consolidated into a home equity loan. In this case, the value of the house, less what is still owing on any mortgage, serves as collateral against the home equity loan. This results in single-digit interest rates, compared with the 19% or higher interest rates of credit cards and most other unsecured debts.