What Does Collateral Mean?

Strictly speaking, collateral is fairly straightforward: It’s the assets you own that can be leveraged to borrow when buying something new, a car or home, for example. But the collateral definition speaks nothing of the wide ranging value of your assets as leverage to continue growing a portfolio of value.

Collateral is one of your most powerful assets when working toward a bright financial future, but you have to learn how to leverage it to its full potential.

How to Use Collateral

Most often, collateral is used to complete a home loan application for those with a less than stellar credit history. Some borrowers can procure unsecured loans for new home purchases—that is, a loan without collateral attached. However, even if your financial institution is willing to extend a line of credit to you without any additional skin in the game, there are some significant advantages to including some of your physical assets as a part of the deal anyway.

Attaching additional contingency items to a loan application adds the benefit of reducing the interest rate you will have to pay or extending the lifetime of the loan so that you can pay less each month. This is particularly helpful for buyers looking to rent or flip houses for immediate cash profit. The less you pay out each month, the less your upfront costs will be before you start receiving a monthly check from your tenants or a payout from a buyer. You will owe back whatever you end up borrowing, so the less you are forced to pay out of pocket before the revenue starts streaming in the better off you will be.

How do you build a reservoir of collateral?

Collateral is a funny thing. It takes money to make money, but cash is the only thing that can’t be used in this way to secure a collateral loan. This means that your income—whether derived from a traditional paycheck or through investment vehicles—needs to go toward building capital in two primary silos. On the one hand, investing in stocks and more traditional savings products will build a cash reserve that you can fall back on in times of hardship or when you retire. On the other hand, it’s also important to begin collecting items of fiscal value that can be leveraged in order to build more capital down the line. Buying collectibles in certain arenas might be a great way to start on this. Another great investment choice is in gold bullion. Gold operates just as any other investment product and fluctuates in price, however, a stockpile of gold can be leveraged for additional purchasing power, whereas stocks or cash reserves cannot. And collateral is only in as much risk as you allow it to be. If you maintain payments, ultimately clearing the loan, then no transfer of ownership must be made. You are simply offering your tangible assets in the event of non-payment.

Real estate is often one of the first pieces of collateral that an investor seeks to put up in order to reduce interest payments. Real estate is a versatile type of collateral and is easily valued by a bank or insurance investigator—unlike a collection of vintage wine, guitars, cars, or baseball cards. Real estate is immediately transferrable and easily resalable, making it a favorite among lenders who can judge exactly what they are being offered without much speculation or specific market-related insight. Building a formidable stable of real estate or other tangible financial instruments in order to leverage better borrowing terms in the future is an essential consideration for any serious investor. It’s a good idea to diversify your portfolio and using collateral to obtain mortgage loans can be a good way to do so.

Rylie Holt