Is it wise to use Collateral for a Loan?

There are many different types of loans and some of them require you to put up something as collateral. This could be your home or your vehicle, for example. It means that if you have trouble repaying the loan over a significant period then the lender will repossess the item that you have put up as collateral. This could mean that you could lose your home or vehicle.

This can put you into a difficult situation. Not having anywhere to live or not having a means of transport, will put you in difficulty. It could be that you will not have enough money for a deposit to rent somewhere so you will have nowhere to live. It could be that you cannot get to work and therefore have to quit your job as there is no way of getting there without a car.

Of course, if we all avoided loans with collateral, none of us would have a mortgage and many people would not buy cars. Therefore avoiding these sorts of loans can be tricky. It can mean that we will not be able to better ourselves if we limit our borrowing like this. Usually borrowing for a home can really help us to improve our lives and finances as we can live rent free once we have one. It can save a lot of money in the long term and give us something to pass on to our children. A car can benefit us too, in different ways. It means that we can travel to specific destinations more easily, without having to rely on public transport. It may be the only way that we can get to work or visit certain relatives. It could be a great way to go out to places or on holiday. It could make a big positive difference in our lives.

Therefore it is a good idea not to panic about these sorts of loans. However, it is sensible to make sure that you fully understand what you are taking on. For example you need to make sure that you know what the repayments are on the loan and that you will be able to afford to pay them back. It is really important to know what the repayment amounts will be so that you can ensure that you will be able to afford them. Therefore before you take out the loan, find out the amount and look at how well you are managing your money each month. Work out whether you will be able to manage those payments or not. Often we can manage to start with, but if we lose our job, have some extra-large expenses or something like that we may find that we struggle to make the repayments. It can be tricky to predict whether something like this might happen and therefore it is hard to plan for. However, you can have insurance which will pay loan payments for you in some circumstances, so you might consider having that but you will have to make sure that you are covered for all situations. Some will only cover for illness, some for redundancy etc, so check the terms carefully.

An alternative way is to have some savings so that you can make the payments if you need to and do not have enough money for your salary. It is usually wise to save some money each month and this could be a good emergency fund for you. However, it might be better if you pay off some of the loan with that extra money. If you can do this, then this could save you a lot of money in interest. If the loan is flexible then you may be able to overpay and underpay which means that you could potentially put in some extra payments when you have spare money but when you do not, they will allow you to pay less. This will depend on whether you have a flexible loan or not and you will need to think about this when you organise your borrowing.

So as long as you are confident that you can make your repayments then using something as collateral on a loan should be fine and has many advantages. However, if you think that there is a risk that you might struggle with the repayments then it would be wise to avoid the loan if you can.

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