The Pros and Cons of Borrowing Against Your Own Assets
January 25th, 2022
If you have assets like a home, car, or retirement account and need cash, you can borrow against those assets. There are advantages and disadvantages to these types of loans. Here’s what you need to know.
Loans attached to items of value are called secured loans or collateral loans. There are as many types of collateral loans as there are types of collateral to secure them. Some of the most common collateral loans are explained below.
A mortgage is a loan that’s secured by your property. If your home is paid in full, you can take out a mortgage for the property’s value.
Home Equity Loan
A home equity loan allows you to take out a loan on the equity in your property – the difference between its value and any loans on it. Unfortunately, even though the loan is for a fraction of your home’s total value, the bank can foreclose on the whole house if you default.
You can take out a loan on almost any financial account, including a 401k. The funds in the account secure the loan, and if you default on the loan, the lender can seize the account to recoup their money.
Passbook loans are like 401k loans, except instead of being secured by a retirement account, they’re secured by a savings or certificate of deposit account.
When your vehicle is paid in full, and you own it outright, you can take out a loan on the vehicle title. The loan is secured by the car, which the lender can repossess if you default.
Pros and Cons of Borrowing Against Your Own Assets
Like any debt, there are advantages and disadvantages to using your assets to secure a personal loan.
Here’s why it can be a good idea to borrow against your assets.
Because assets with actual value secure collateral loans, there’s no complicated underwriting process. It means that you and your lender get to decide the terms of your loan.
Lower Interest Rates
Interest helps lenders protect themselves against the risk of lending money. Secured loans are less risky, so many lenders will charge a lower interest rate, which saves you money in the long run.
Lower Credit Scores
Lenders use credit scores to evaluate how likely you are to repay the loan and how likely they are to lose money on the deal. Because of this, you can often get one with a lower credit score than an unsecured loan would require. They can even help you rebuild your credit!
You can often get a larger secured loan than an unsecured loan because secured loans are backed by real money. Less risk to the lender means more money for you.
Assets have value, but they aren’t liquid, so it isn’t easy to move or spend. Taking out a loan against your assets gives you access to their value without selling them.
The bad parts of borrowing against your own assets include the following.
Loss of Collateral
Secured loans are straightforward for lenders to collect on. If you default on your loan, your lender will seize the collateral.
Collateral on Hold
If your collateral is an account of some sort, the lender will often freeze the portion of the account that secures the loan to prevent you from withdrawing it.
This is a case of needing to have money to get money. If you don’t have any assets to post as collateral, you can’t get a collateral loan. Without assets, unsecured loans are your only option.
Collateral loans are a great option if you have valuable assets to borrow against, but they put those assets at risk. Evaluate the pros and cons of any financial decision, especially when your property is on the line.