Obtaining a loan is a necessary step for achieving major life goals such as buying a home, renovating a house, starting a business, purchasing a car or even covering personal needs both in personal banking and business banking. One of the key aspects of any loan is that banks and financial institutions want to ensure that they will recover the money they lend you.
This is where collaterals, or guarantees as they are wildly known, come into play. To learn more about what collaterals are and why they are necessary, keep reading.
What is collateral?
Collateral is any asset that the borrower “offers” to the bank as a guarantee that the loan will be repaid. For the bank, the asset acts as a safety net. In case the borrower fails to repay the loan, the bank can then acquire ownership of the asset.
In simple terms:
- You apply for a loan at a bank.
- The bank, in order to approve the loan, asks you to provide collateral so that the borrowed amount is covered in case of non-repayment.
- The collateral that is used as security may also affect the interest rate of the loan, depending on its value.
- When the loan is repaid, the collateral is “released” by the bank.
- In case of non-repayment of the loan, the bank has the right to liquidate the collateral to recover the outstanding amount.
For some loans, it depends on the bank’s policy whether a guarantee is required or not. For example, with Housing Loans, the bank may require a mortgage on the property for the loan to be approved. It is important to note that no collateral can cover the full value of the loan.
Important note: The collateral does not pass into the possession of the lender during the repayment of the loan, but remains in the possession of the borrower.
What can serve as collateral?
Collaterals are made up of either tangible or intangible assets. Tangible assets can be any physical property such as land, residence or a car. Intangible assets on the other hand mainly consist of deposits, life insurance policies or other financial assets.
What are the types of collateral?
Collaterals are divided into various categories based on the type of asset used:
1. Mortgage
The most common type of collateral, especially concerning Housing Loans. Essentially, it is the property that will be purchased or already belongs to the borrower, which is placed as a mortgage (collateral) for the loan.
2. Provision of personal guarantee
A natural person, also known as a Guarantor, who commits to repay the loan in case the borrower fails to do so.
3. Pledge agreement of movable property
This includes assets like cars, machinery or business equipment, which can serve as collateral.
4. Deposits
These are financial assets, usually Fixed Term Deposit Accounts.
What is a mortgage?
A mortgage is a form of collateral, primarily used in high-value loans, such as Housing Loans. Essentially, it refers to when, during the loan agreement, real estate, such as a residence or land, is pledged as collateral to the bank.
This does not mean that the borrower loses ownership of the property; they remain the owner, but the property is ‘secured’ until the loan is fully paid off.
In the event that the borrower cannot repay the loan, the bank has the right to sell the property to recover the outstanding loan amount.
The term mortgage specifically refers to collaterals that are real estate. Not all types of collaterals are considered mortgages. Loans secured by real estate are also called mortgage loans.
What is the significance of collateral on a loan?
For the bank, the collateral minimises the risk of non-repayment. At the same time it gives the bank the right to liquidate the collateral in case of default by the borrower.
For the borrower, a collateral can provide access to larger loan amounts and may lead to a lower interest rate, depending on each bank’s policy.
Loan with collateral and loan without collateral: What is the difference?
Loans with collateral are also known as Secured Loans while loans without collateral are referred to as Unsecured Loans. Mostly Personal Loans, under circumstances and depending on the requested amount, have the option to be provided without collateral.
- Secured loan: The borrower provides an asset as collateral to secure a loan. It usually results in a lower interest rate and larger loan amounts.
- Unsecured loan: No asset is required as collateral for loan approval, and it is based on the income and credit history of the applicant. These loans usually concern smaller amounts and have higher interest rates.
Collateral is a key element of the banking system in Cyprus particularly in loan agreements. On one hand, it protects the bank while on the other, it can offer the borrower better loan terms. Although collateral comes with responsibilities for both parties, it opens the door to greater opportunities such as acquiring a home, developing a business, or covering emergency needs.
At Ancoria Bank, we prioritize transparency regarding the terms and obligations governing our loan agreements. We consider it particularly important for customers to clearly understand all the information they need before proceeding with any loan agreement, such as that if they do not meet the repayment plan of the loan, they may lose their home, that there are charges for early loan repayment, as well as that the amount of the instalment and the total cost of the loan may increase or decrease depending on variations in the base interest rate. Our professional Relationship Officers are happy to help you with any of your loan needs, so you can achieve your goals. Our aim is not just to offer a loan, but to help you manage it properly and responsibly.
