Anyone who has taken out a loan before knows the procedure: banks require — regardless of the loan amount — certain loan collateral that the bank can realize if the loan is not repaid.
Not every borrower immediately knows which collateral is most valuable and thus most suitable for the bank in a loan (security in rem, real estate). For this reason, these will be compiled and examined in more detail here.
Why is loan collateral useful?
Loan collateral primarily serves banks as an additional instrument to secure a loan. Although creditworthiness (credit rating) is checked for every loan, this is always only a snapshot and does not say how the borrower's financial situation will develop during the loan term.
If the borrower becomes insolvent, the collateral would be used to satisfy the creditors. The risk for the lender is greatly reduced by these securities.
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Which types of loan collateral exist
In general, two types of collateral are distinguished in a loan: personal collateral and real collateral.
⦁ Personal collateral involves the liability of the borrower or a second or third person. If the loan amount is very high, the bank may require several people to assume liability.
⦁ In contrast, with real collateral you are liable with asset items (also called security in rem), which you legally transfer to the bank for the duration of the loan term.
In addition, a distinction can be made between security transactions and fiduciary transactions. The former are provided by means of a guarantee, a pledge or a mortgage, while in a fiduciary transaction a transfer of ownership for security or the registration of a land charge is carried out. (Security transfer of ownership: in banking this means collateralization by movable goods and sets of goods. In a security transfer of ownership, the credit institutions acquire ownership by transfer. The grantor of the security is left with possession for further use of the items.)
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Loan collateral: What the bank may require
What sounds rather dry and complicated at first glance is often not required for a standard loan. Private individuals should not expect the bank to demand complicated forms of collateral. Rather, there are some common types of loan collateral that will be explained in more detail below.
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Guarantee as security for a loan
A guarantee is probably the most common form of collateral for a private loan. As a borrower, you must provide the bank with a solvent guarantor who, in the event of non-payment of the obligations, assumes the obligation and services the loan installments until either the borrower is able to do so again or the loan is repaid.
If this happens, the guarantor automatically obtains a claim against the original debtor. This means that the guarantor can legally reclaim the money from the borrower via a claim.
Land charges as loan collateral
This type of collateral is mainly used in real estate financing. With a pledge or land charge you have the option of securing the loan by pledging an item — specifically: a property or even a plot of land.
The land charge (pledge) is put on a legally secure footing by entry in the land register. This entry (security), called a land charge (Grundschuld), only expires when the financing is completely finished.
It is also possible for several land charges to be registered in the land register at the same time. The land charge that was entered first has the highest possible priority. If the bank has a right to the collateral, the first land charge is always satisfied first. All further entries are satisfied in order.
Mortgages are also suitable as loan collateral
Mortgages are also mainly used in real estate financing. The property is burdened as security with a monetary claim that is intended to serve as security. This option is especially popular for long-term loans.
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Residual debt insurance
Residual debt insurance is often required by banks in combination with a guarantee as security. With this, the borrower can protect themselves against unforeseeable risks such as job loss, incapacity for work or death.
If such insurance is taken out, it not only provides security for the borrower and the lender but also for the guarantor. The guarantor no longer has to step in if the insurance pays off the residual debt.
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Term life insurance as loan collateral
Term life insurance is a life insurance policy that only pays out in the event of the borrower’s death. It is limited to the duration of the financing and is frequently used to secure mortgage loans.
Many banks require term life insurance from their borrowers. However, no one is obliged to take out this insurance with the bank. Instead, you should look for the most affordable provider.
These topics may also be of interest to you: Creditworthiness, Creditors, Loans.