Using collateral loans to borrow against your assets - asking the experts

Personal loans are a big commitment, but if you’ve been learning towards a secured personal loan and aren’t really sure how this whole collateral thing works, you’re not alone. This is one of the more frequently asked questions about personal loans - and we want to help clear things up!

We’ve reached out to Mozo’s resident banking expert, Peter Marshall, as well as David Norman, the chief operating officer of online personal loan lender NOW Finance, to help explain the pros and cons of secured loans.

What is a secured personal loan? 

A secured personal loan (or collateral loan) is a type of personal loan that requires the borrower to put up an asset against the loan as security. Because these loans are lower risk for the lenders - no one wants to lose the collateral they have attached to a loan - they will often come with lower interest rates.

Along with lower interest rates, a loan with collateral might also include benefits like 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 stresses that though collateral might be good to bring down the rate on your loan, having a healthy credit rating 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.” 

Norman adds: “Lenders assessing applications for secured loans may put a lower emphasis on factors like credit score and 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. Car loans are almost always secured loans, with the car you’re purchasing being used as collateral on the loan.

“The most common assets used as collateral in a secured personal loan are houses and vehicles,” 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 average interest rate for a multi-purpose collateral loan (not just a car specific loan) in the Mozo database is currently 7.97% p.a. For contrast, this is nearly 2% lower than the average interest rate for an unsecured loan in the Mozo database, which currently sits at 9.69% p.a.

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, so any extra low advertised rates might not be the end result.

The current maximum loan amount for secured loans in the Mozo database range from $50,000 to $250,000 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. Secured borrowers also have on average a credit score between 701 and 733, putting them in the good to excellent credit score range.  

What happens if I can’t pay back a collateral loan?  

When you put up collateral on a loan, it is putting your lender’s mind at ease that you will pay back your loan and making you a less risky borrower. This is especially appealing for borrowers with poor credit history or an infrequent or low income. 

So what happens if you can’t make your repayments? This is a pretty worst-case scenario.

If you default on a secure loan (aka don’t pay it back), the lender can repossess and sell your asset in order to cover the loan balance that you haven’t paid back.  

If the sale of the collateral 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 you road test your repayments to make sure that you can comfortably repay the borrowed amount without drastically affecting your lifestyle. Calculate repayments you can make comfortably with a loan repayments calculator.

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 aren’t able to afford to fix in case of 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 Mozo’s best personal loans, or explore our personal loans database to find more choices.