What does it mean to provide collateral for a loan and what does it entail?
SAVINGS AND INVESTMENT I September 10, 2020
Providing collateral for a loan means guaranteeing the return of the money that has been lent to you by providing an asset as security.
Typically, when you apply for a loan, you offer your personal guarantee to cover the repayment of the loan, in other words, you guarantee it with all your assets, present or future. In some cases, the bank or the lender may ask you for an additional guarantee in order to release the money: the security of an asset as collateral. This involves leaving one or more physical or financial assets as a guarantee that you will fulfil your obligation: a vehicle, a bank deposit, shares... You can do this yourself, as the recipient of the loan, or through a third party, who, instead of acting as guarantor, pledges an asset of their own, thus limiting the risk.
A collateralised loan instead of a mortgage loan (where payment is guaranteed by the value of the property) is cheaper to arrange, as there is no need to pay costs such as valuation and/or administration fees. In a loan with a collateral guarantee, all you have to do is go to the notary to formalise the agreement in a public deed or in a policy that will be notarised.
Also, by providing a collateral asset as an additional guarantee of payment, you are likely to have access to more capital and/or a more competitive interest rate.
Unlike a mortgage, where you can continue to use the mortgaged property while you are paying for it, by collateralising a loan the collateral security may pass into the hands of the lender, and you may not have the use of it during the life of the loan. However, if it is a financial asset, such as shares or an investment fund, it can still generate a return for you.
In the event that you fail to pay the loan instalments secured by collateral, the bank can enforce its right to keep the pledged asset and thus recover its money. If it is a physical asset, it would be put up for public auction, whereas if it is a financial asset, it would be realised to recover the borrowed capital (e.g. if it is a share, the lender would sell it, and if it is a fund investment, it would liquidate it).
Find out more here about the characteristics and requirements of Banco Santander's range of loans.
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