Welcome back to Making Cents of Finance! Last time, we talked about the second of the 4 C’s of Credit—Capacity. This time, we’ll dive into Collateral. We’ll look at what lenders consider collateral, what is not considered collateral, and how it weighs into lending decisions.
What is collateral?
Simply stated, collateral is a sort of physical promise to lenders that they’ll get their money back. If the borrower somehow fails to hold up their end of the agreement, the lender is then able to take possession of the piece of collateral agreed upon in the terms of the loan.
Collateral is generally a sort of property or asset such as a home or a vehicle that acts as a bit of security for the lender as well as an incentive for the borrower to make their payments on time.
Is Collateral always required?
As with all things credit-related, the answer is complex and dependent on your creditworthiness. Some credit accounts require borrowers with challenged or no credit history to put down a sort of collateral. An example of this sort of account would be a secured credit card, in which a cash deposit is required for a borrower to be approved for the account. This deposit is generally considered refundable after certain lengths of time, but also acts as a sense of security for the lender in case the borrower misses multiple payments.
Larger, more high-risk loans such as financing a vehicle or mortgaging a home require collateral no matter the borrowers credit circumstance. The collateral for these types of loans are often the property or asset being financed.
How does this factor in?
Personal creditworthiness factors into collateral by showing lenders how responsible a borrower has been historically. The more responsible a borrower has proven him or herself to be, the more likely lenders are to extend credit with diminished or no collateral as well as being able to finance larger amounts.
Join us for our next installment of Making Cents of Finance, where we will be finishing up with the 4 C’s of Credit as we talk about conditions.