What is collateral and how does it work in the mortgage loan process? – Bankrate.com

April 18, 2022 By admin

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If you’re buying a home with a mortgage or refinancing, the mortgage lender needs to be confident you’re going to be able to repay the funds. A strong credit score and a history of smart financial decisions can provide some degree of assurance, but a lender also relies on the collateral that secures the loan — the home — to make the approve-or-deny decision.
Collateral refers to an asset that a borrower offers as a guarantee for a loan, such as a mortgage. When you obtain the loan, the lender puts a lien on the collateral. The lien stipulates that the lender can seize the collateral if you don’t repay the loan under the terms of the contract. Once you repay the loan, the lender removes the lien and no longer has a claim to the collateral.
No matter what you use as collateral or what you want to do with the money you borrow, the definition remains the same: It’s your offering to help secure a loan.
Collateral applies to all kinds of secured loans, not just mortgages. (There are also unsecured loans that don’t require it.) For example, if you’ve paid off your car in full and the title is in your name, you can use that asset as collateral to borrow money for another expense. In this case, a lender can reasonably expect that you’ll pay the money back. If you don’t, the lender is legally able to take your car.
Collateral doesn’t necessarily have to be property, either. Some lenders let borrowers use their savings account as collateral. For instance, if you have $3,000 in your bank account or a CD, you might be able to use that as collateral to borrow more money. If you don’t repay the money you borrowed, the lender can take your cash in that account instead.
There are rules around how a lender can recoup losses, however, depending on whether the loan is a recourse or non-recourse loan.
In the case of a mortgage, the collateral is the home, also referred to as “real property.”
When determining whether to approve your loan, the lender will order an appraisal of the home to ensure that the property — the collateral — is actually worth what you propose to pay for it with the loan. If it isn’t, the lender can deny the mortgage because the asset isn’t worth the risk.
On the other side of things, if you don’t repay the mortgage and can’t come to a relief agreement with your lender, the lender can foreclose on the home, and you’ll lose that collateral.
The concept of collateral might sound a bit daunting — no one wants to entertain the possibility of losing something of value, particularly if it’s the roof over your head. However, collateral plays a key role in helping you secure the money you need to buy that roof. Whether getting a mortgage or any other type of secured loan, when a lender asks for collateral, make sure you have the means to pay the loan back. Otherwise, that collateral could wind up in the lender’s hands, and you’ll lose that asset.
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