Personal loans have become popular these days because of their simplified application process that requires minimal paperwork and no collateral. These factors make a personal loan a democratic financial tool that can support everyone’s immediate financial needs. However, you can still use collateral for your personal loan. But how do you choose if you want to take a secured or unsecured personal loan? Keep reading to find that out!
What is a Collateral?
Collateral is any physical asset like a home, a car, or existing funds that a borrower offers up as a guarantee to the lender. It shows a potential borrower’s creditworthiness and an option to recover the loan in case the person fails to pay it back. If the borrower fails to pay the EMI on time, the lender can seize the collateral to help compensate for its financial loss.
Benefits of Using Collateral for a Personal Loan
Getting a personal loan against a collateral comes with a range of benefits, including:
- Lower Interest Rates
Since lenders can now see a form of security against the loan that they are extending, it eases the risk factor for them. Therefore, they can offer personal loans at lower interest rates, which are usually relatively high for unsecured personal loans. As a result, borrowers can enjoy more cost-effective financing.
- Higher Loan Amounts
Without collateral, personal loans can only finance a limited amount. This is major because of the factor that they do not have anything to mitigate the risk of loan fraud. However, if they have collateral, it can act like a safety blanket, allowing the lenders to approve higher loan amounts. This can be advantageous for significant expenses like home renovations, setting up a business, or other major life events.
- Improved Approval Odds
If you are new to the world of personal loans or your credit history needs to be better, having collateral ready can significantly increase your chances of getting approved for a personal loan. Lenders may be more lenient with credit requirements when there’s an asset supporting the loan.
- Extended Repayment Periods
Unsecured home loans are usually extended for a shorter duration, which can increase the monthly burden on your pockets. Collateral-backed loans may offer more extended repayment periods. This flexibility can be advantageous for borrowers looking to manage their monthly cash flow more comfortably.
Disadvantages of Using Collateral for a Personal Loan
While there are several benefits of using collateral for a personal loan, there are a few drawbacks:
- Risk of Asset Loss
The most significant drawback is the risk of losing the pledged asset if the borrower defaults on the loan. This is a critical consideration, especially for borrowers who may face financial uncertainties in the future.
- Lengthy Application Process
Secured loans often involve a more extensive application process compared to unsecured loans. Lenders may require detailed appraisals and documentation of the collateral, leading to a longer approval timeline. Therefore, using collateral for personal loans in case of emergencies might not be the best idea.
- Limited Asset Options
Not all assets are eligible or practical for use as collateral. Borrowers may find their choices limited based on the type and value of assets they own. Additionally, certain assets may be essential for daily life, making it less feasible to secure a loan.
- Impact on Credit Score
While collateral can mitigate credit risk, the loan process itself may still impact the borrower’s credit score. Late payments or defaults can have lasting consequences on creditworthiness.
How to Make the Decision?
The decision to use collateral for a personal loan varies from person to person and on various factors. You must, however, carefully analyse your financial security, loan purpose, loan amount, risk tolerance, and loan terms before deciding if you want a secured or unsecured personal loan.
If you are still deciding if you should use collateral for personal loans or not, you can take the help of trusted lenders like Tata Capital.
They can help you in this pursuit by sharing valuable tips and insights while offering collateral-free loans. They can guide you with various options and details of the loan terms to support your loan amount for full transparency. So, if you still need clarification about using collateral for a personal loan, you must get immediate financial advice from the professionals of Tata Capital.
