Ask the experts: Is using collateral against a personal loan a good idea?

woman considering online secured personal loan

If you’ve been weighing up whether to take out a secured personal loan but are not really sure how this whole collateral thing works, you’re not alone. This is one of the more frequently asked questions about personal loans. 

We’ve sought out answers from Mozo’s banking expert, Peter Marshall, and David Norman, the chief operating officer of online personal loan lender NOW Finance, to help explain the pros, cons and key considerations when using collateral to secure a loan.

What is a secured personal loan? 

A secured personal loan is a type of personal loan that requires the borrower to put up an asset against the loan as security, also known as collateral. Often these loans come with lower interest rates, as secured borrowers are perceived as a lower risk to a lender by securing an asset against the loan.

The benefits of a secured loan, along with lower interest rates include having access to more extended repayment periods and the potential to borrow more money. 

NOW Finance’s David Norman explains, “Given the presence of an asset as security, and thus the reduced risk of being left out-of-pocket by a loan not being repaid, lenders usually offer lower interest rates to secured borrowers. For the same reasons, higher loan amounts may also be accessible to secured borrowers.”   

How are credit scores used when assessing secured loans? 

Mozo’s Peter Marshall said that it’s important to remember that while having an asset is good to get a lower rate, having a healthy credit rating as well is even better. 

“Risk-based pricing means that often the best secured personal loan rates are reserved for customers with good credit scores,” Marshall says. “Customers that have both an asset and an excellent credit rating when applying for a loan are favoured by lenders, as they are the least risky type of borrowers.” 

According to Norman, “Lenders assessing applications for secured loans may put a lower emphasis on factors like credit score/history and income than they would when assessing an unsecured loan. However, the most responsible lenders will place emphasis on these factors in any assessment regardless of the type of loan.” 

What can be used as collateral on a personal loan?

There are many options when it comes to putting up collateral against a secured personal loan, from your car, your home to the boat in your garage. 

“The most common assets used as collateral in a secured personal loan are houses and vehicles. At NOW Finance, we accept applications with a motor vehicle, water-based vehicle, such as a boat or similar, or a caravan as collateral,” Norman says. 

 “Every lender will have different criteria for what you can use as collateral against a secured loan. For example, some may specify that secured loans are only available for homeowners, as they will insist your property is the collateral.”

How do secured personal loans compare?  

When it comes to interest rates, the Mozo database average variable interest rate multi-purpose secured personal loan rate currently sits at 7.21%

“Over the past few years there has been some movement in the personal loan interest rate space, with the lowest car loan rate on the Mozo database now starting with the number three,” Marshall says. 

 But Marshall reminds borrowers that many lenders have adopted the risk-based pricing model, which means that lenders offer a range of rates and tailor them depending on a customer’s credit history. 

The maximum loan amount for secured loans ranges from $50,000 to $100,000 with loan terms up to 10 years. 

For secured loans funded by NOW Finance, “the average loan size ranges between $27,000 and $34,000 and the average loan term sits around 5 years,” says Norman. Secured borrowers also have on average a credit score between 701 and 733, putting them in the good to excellent credit score range.  

How does collateral work?  

As mentioned, collateral refers to an asset that works as security against a secured personal loan. 

So, what happens to that asset if you can’t pay back a secured loan? 

If a borrower defaults on the loan (doesn’t repay it), the lender is able to repossess and sell the asset in order to cover the remaining unpaid balance on the loan.  

And sometimes if the sales of the asset doesn’t fully recoup what you owe you may still incur additional fees and charges as a consequence, says Norman. 

Like all forms of borrowing, it’s important to remember that there are risks involved with taking out a secured personal loan. Prior to making an application, Marshall suggests to roadtest your repayments to make sure that you can comfortably repay the borrowed amount without drastically affecting your lifestyle. 

Marshall also says to make sure that you also take every precaution to protect your asset. 

 “If you are securing your loan against a car, then making sure that you’ve got that car comprehensively insured is a must. You don’t want to find yourself in a situation where you are paying off a loan for a car that you are not able to afford to fix if you were in an accident.”   

What other personal loan options do I have? 

If the idea of putting up collateral against a personal loan doesn’t sound like the right option for you, an unsecured personal loan is also a solid borrowing choice. 

“With an unsecured loan, there is no need to put up collateral against the loan as security, so there is no risk of losing any of your assets,” Marshall says. 

“However, consumers are more likely to face higher interest rates by not securing a loan and may have more restrictions on the amount or length of time you can borrow for.” 

Still deciding which personal loan option is best for you? Check out these deals below or jump over to our personal loan hub for more providers and even more info!

Compare personal loans - last updated 2 July 2022

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