What does collateral mean and how does it work?

Loans can be broken down into two main categories: those secured by collateral and those that do not have collateral. In this situation, collateral means an asset of value, such as a home or car, that is used to reduce the lender’s risk, helping the borrower qualify for the loan more easily or secure a lower rate.

While collateral loans are usually cheaper than unsecured loans and can be easier to qualify for, they come with risk. Failing to pay your debt could result in the lender repossessing the asset you pledged as collateral.

Collateral meaning

Collateral is an asset of value that a borrower pledges as security to reduce a lender’s risk when they offer a loan. If the borrower defaults on the loan, the lender is allowed to repossess the collateral.

Common forms of collateral include real estate and cars. For example, mortgages use property as collateral, and the lender can foreclose on the home and take possession if the borrower stops paying their monthly bill.

An unsecured loan works differently. Unsecured loans have no security for the lender beyond your promise that you’ll pay the money back. There’s no asset to repossess, though the lender can sue for non-payment and ask a court to compel you to pay or sell assets to pay the debt.

Collateral loans have the benefit of being safer for lenders, making them easier to qualify for and usually giving them lower interest rates. They encourage responsible borrowing, but mean the borrower must accept the risk of losing their collateral.

Examples of collateral

If you’re applying for a secured loan, these are some of the most common forms of collateral you can use.

• Real estate: Property, such as a home, commercial real estate, and land, is commonly pledged as collateral. Real estate typically has significant monetary value, allowing borrowers to secure larger loans.
• Cash: Cash deposits or savings accounts can serve as collateral for loans. Lenders may hold some of your cash as security, making this a straightforward option for securing financing.
• Vehicles: Lenders often accept cars, trucks, and other vehicles as collateral.
• Investments: Stocks, bonds, and mutual funds can also be used as collateral. Borrowers can access loans without needing to sell their assets by using investments to secure loans, but lenders often require a margin account.
• Equipment: Businesses often use equipment like machines or computers as collateral. This helps them get more funding by using what they already own.
• Inventory: Similar to equipment, inventory can also be used as collateral to secure business loans.

Types of collateral loans

These are some of the most common types of collateral loans.

• Mortgage loans: When you get a mortgage, the property you purchase serves as collateral. The lender holds a lien on your home and can foreclose if you default on the loan.
• Auto loans: Similarly to mortgages, auto loans are secured by the car you used the loan to buy. Lenders can repossess the car if you miss payments.
• Home equity loans¹ and HELOCs: Home equity loans and HELOCs both use the property you’re drawing equity from as collateral. Home equity loans offer fixed rates and lump sum funding, while HELOCs let you draw from a pool of funds multiple times, on an as-needed basis, and usually have variable rates.
• Secured personal loans: Secured personal loans are flexible loans you can use for many purposes, such as consolidating debt. Common forms of collateral for these loans include cars and certificates of deposit held with the lending bank.
• Secured credit cards: A secured credit card works like any other credit card, except that you need to deposit cash with the card issuer to qualify. Usually, your credit limit will be equal to the amount you deposit. People commonly use these cards to help them build credit.

Pros and cons of collateral loans

Secured loans are usually easier to qualify for than unsecured loans, but they do mean taking on the risk of losing your collateral. Before applying for one, consider these pros and cons.

How to get a collateral loan

If you think that getting a secured loan is the best choice for you, you’ll need to go through a multi-step process to apply for the loan, put up an asset as collateral, and secure funding.

1. Check your credit score and history

Before you apply for any loan, it’s important to take a moment to check your credit score and history. Your credit score has a big impact on your ability to qualify for loans and the interest rates that you pay, so the better your credit, the easier it will be to get a good deal on a loan. On the other hand, even with collateral, poor credit could mean high rates or even getting denied for a loan.

When you check your credit, look for errors you can contact the bureaus to remove, as well as for any factors that may be dragging your score down. Then, work to improve those aspects of your score.

There are many services that will let you view your credit score. By law, you can use AnnualCreditReport.com to get one free copy of your credit report from each bureau once per year.

2. Shop around for loans and get preapproved

Once you’re comfortable with your credit score, the next step is to shop around. Each lender is different and will give you a different quote for interest rates, loan amounts, and loan terms. Each lender may also have different collateral requirements.

You may wonder about the difference between prequalified versus preapproved. A prequalification is generally based on self-reported information, while a preapproval is based on a more thorough review of your finances and is more accurate than a prequalification.

You may want to go through the preapproval process with a few different lenders so you can get multiple quotes. Then, you can move forward with the loan that best fits your needs.

3. Compare loan offers

Once the lenders have sent you preapproval letters, you can review them and compare the details of each loan. The key things to look at are:

• Interest rate. Lower rates mean lower monthly payments and a lower overall cost.
• Repayment term. This is the length of time it will take to pay the loan back. Longer terms result in lower monthly payments but tend to cost more overall than loans with shorter terms.
• Fees. Some lenders charge additional fees, like origination fees or early repayment fees, that can increase the total cost of the loan. Try to avoid fees where you can.
• Collateral requirements. Some loans, like mortgages and auto loans, are automatically secured by the thing you’re buying. With others, like secured credit cards or personal loans, the collateral requirements may vary from lender to lender.

4. Gather your documentation and apply for the loan

When you’ve decided which lender is right for you, it’s time to officially apply for the loan. Your lender will want to see a number of different documents to confirm details about your finances. Below are some documents commonly requested by lenders.

• Paystubs
• A photo ID
• Tax returns
• Bank account statements
• Investment account statements
• Loan statements

Depending on the type and size of loan, underwriting and approval could take less than a day or as long as a week or more. Being organized and having these documents ready can both speed up the process and help improve your chances of getting approved.

5. Receive the funds

If and when the lender approves your application, it will begin the disbursement process. Disbursement is when the lender sends the money to you.

Once the loan is disbursed, you can use the money. It also means interest will start accruing, and you have fully taken on responsibility for making the required payments.

The bottom line: Understand collateral before you take out a loan

Loans come in two basic forms: secured and unsecured. Secured loans are secured by a valuable asset, like a home or car, which is called collateral. The lender can take possession of the collateral if the borrower misses payments, reducing the lender’s risk. That makes collateral loans easier to qualify for and gives them lower interest rates, but it does mean that borrowers have to accept the risk of offering up an asset as collateral.

If you’re hoping to buy a home, you’ll likely need a mortgage, which uses the home you buy as collateral. You can reach out to Rocket Mortgage^® to see what you qualify for.

¹ Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 11/19/25 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00 (minimum loan amount for properties located in Michigan is $10,000.00). Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Ameriprise products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.