When you apply for a loan, the lender wants some assurance that you will repay the loan. In some cases, a lender will accept a sterling credit history and proof that you have an excellent income instead of security on the loan. More often, the lender prefers to get collateral on the loan. What is collateral for a loan? It’s an asset of value that you will forfeit to the lender if you do not make the payments you agreed to. Home mortgages and car loans are typical examples of loans secured by collateral.
What is Collateral?
When a lender accepts an asset with monetary value to secure a loan, that asset becomes the collateral on the loan. Collateral provides the lender with some security that they won’t lose their money. The collateral remains in your possession until or unless you default on the loan. At that time, the lender may seize the asset, sell it, and use the proceeds to offset the money lost in making the loan.
Collateral can be a house, property, cars, boats, gold, bank savings deposits, investment accounts, or any other valuable asset the lender agrees to accept to secure a loan. When the lender draws up the loan contract, you pledge to forfeit the collateral (home, property, etc.) to the lender if you cannot repay the loan.
How Does Collateral Work?
Before a lender agrees to give you a loan, they want some protection from taking a total loss should you fail to repay the loan. If they accept an asset of yours for the loan’s collateral, this is a secured loan. A secured loan protects the lender’s interest in two ways. First, because you, the borrower, would have to forfeit your asset, you’ll be more motivated to find a way to make the loan payments. And second, if you default on the loan, the lender is not left empty-handed — they have your collateral which they can sell.
Suppose the borrower of a loan secured by collateral fails to make their loan payments. In that case, the lender will first charge late fees and other penalties. If the loan payments do not resume, the lender may repossess the collateral to sell it or send the account to collections. However, it doesn’t end there. Most loans secured by collateral are known as “recourse loans.” Recourse loans allow the borrower to go after the borrower’s other assets if repossessing and selling the collateral doesn’t clear the debt. If the sale of the collateral does not cover the outstanding loan amount, the lender may then engage a collections agency to help them to recover the rest of the money.
For instance, let’s say you take out a car loan of $30,000 on a new car. You put down $10,000 and financed the rest with the car as the loan’s collateral. You agreed to make $700 payments every month for 72 months to repay the loan and the loan’s interest. Your payments were on time for the first ten months, but you stopped making payments and defaulted on the loan. The lender is still out $23,000 plus interest, so they repossess the car and sell it. However, due to depreciation and wear and tear, the car sells for just $15,000. The lender can then send the account to collections to recover the remaining debt.
Key Takeaways for Understanding How Collateral Works
- Collateral is used to minimize risk to the lender of making a loan.
- Collateral is any valuable asset that is used as security for a loan.
- If you default on the loan, the collateral may be seized and sold by the lender to recover their losses.
- Often, collateral may be a house or car, but a lender may accept other property or assets.
Types of Collateral
While many assets can serve as collateral if the lender accepts them, collateral is often determined by the type of loan you take. For car loans, the car is typically the collateral used. For a residential mortgage or a home improvement line of credit, the house serves as the loan’s collateral. Payday loans and similar loans offered by banks use your future paycheck as the collateral on their loans.
What if You Don’t Have Collateral for a Loan
Lenders use collateral to secure loans and protect their interests, so what if you don’t have collateral for a loan? Do you always need collateral for a personal loan?
Without collateral, you cannot get a loan from a lender who requires it. But there are other options. Some lenders will agree to provide certain loans without collateral. This is known as an unsecured loan. For example, most credit cards do not require any collateral, so charges on credit are considered unsecured loans.
If the borrower defaults on an unsecured loan, the lender can assess late fees and other penalties, eventually sending the account to collections. Like most secured loans, unsecured loans are also “recourse” loans, meaning the lender can attach your assets to get the loan repaid. For instance, the lender may be able to get a garnishment on your wages. This means that your employer must deduct money from every paycheck before you get your pay. Then, that garnishment is sent to the lender to repay the debt.
The Benefits of Collateral
Any loan is a gamble for the lender because they provide money in exchange for the promise of repayment with interest. If the borrower takes the money and runs, that leaves the lender with nothing. In the event of a loan default, collateral and the ability to go after the borrower’s other assets to repay the loan (recourse) lowers the risk for the lender.
While collateral helps to mitigate the lender’s risk, secured loans or collateralized loans also benefit the borrower. Typically, secured loans charge a much lower interest rate than unsecured loans. For reference, think of how low your mortgage rate is compared to the interest on your credit cards. So having a valuable asset to offer as collateral can secure a borrower a better loan with more favorable terms for the borrower. And the more the value of the collateral exceeds the value of the loan, the lower the interest rate may be.
What is Collateral for Legal Funding Loans?
In the case of legal funding, the anticipated settlement serves as the collateral on the loan. This is what allows a lender to provide a plaintiff a lawsuit loan, similar to a cash advance. When a plaintiff has a strong case that proves extensive damages, their future settlement can be a very valuable asset, potentially worth several million dollars. However, even the strongest personal injury case may take years to resolve, leaving the injured party facing stacks of bills while their lawsuit grinds on.
What Does Collateral Mean for Legal Funding Loans?
Despite also requiring collateral, lawsuit loans are very different from all the loans discussed thus far because they are structured as non-recourse loans.
Remember that with the recourse loans described above, the lender can seize the loan’s collateral, sell it, and keep all the proceeds to recoup their losses on a defaulted loan. And, if the sale of the collateral falls short of the loan’s value, the lender can pursue your other financial assets, like your savings and your future income, to repay the debt. With a non-recourse loan that is simply not possible because the collateral is a future payment that the borrower has not yet received.
How Does Collateral Work in a Non-Recourse Loan?
With a non-recourse loan, like legal funding, the lender has no recourse to attach assets other than the loan’s collateral. A legal lender, like Tribeca Lawsuit Loans, cannot send an account to collections, cannot garnish your wages, or put a lien on your property. This is because non-recourse loans can only be repaid using collateral. However, legal lenders cannot take the whole settlement to repay the loan either. This is because the loan’s collateral is just a specified portion of the lawsuit’s future settlement.
Because legal funding can be repaid solely by your future settlement as the collateral on a non-recourse loan, it is risk-free for the borrower.
When you take out a lawsuit loan, your future settlement is the collateral on the loan. You get your money now to alleviate the financial stress. We wait for the lawsuit to be settled and your compensation to be sent to your attorney. At that point, your attorney will cut us a check to repay the loan. There are no monthly payments to worry about.
The purpose of legal funding is to help plaintiffs through times of financial distress while helping them get the settlement award they deserve.
At Tribeca Lawsuit Loans, we can provide you with a risk-free, non-recourse loan of $500 to $2 million within just 48 hours to help you get the best possible compensation for your lawsuit. We charge low, simple, non-compounding interest rates and are ready to fund your fight for justice. Contact us — we can help!