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What is the loan collateral?

Collateral in banking generally refers to certain loan collateral provided by a borrower to secure a loan to the lender. Loan collateral can be an existing asset or future income of the borrower. A land charge on a property, a mortgage on a property or a guarantee by a third party can also be used as collateral for a loan.

How are the required loan securities determined?

How exactly the security of the individual loan is determined depends on the term and the amount of the loan. It can range from a simple retention of title upon delivery of goods to a land register entry or the direct pledging of other assets.

Why does a loan require collateral?

Loan collateral is a necessary agreement and usually a requirement for a loan application. If the borrower has an insufficient credit rating or demands a certain loan amount, he must provide a security. This can be a land charge, a mortgage on a house or the guarantee of a relative who has corresponding assets.

If the borrower is unable to pay off his loan, the creditor has the option of calling in the deposited loan collateral. If the security falls from the debtor to the creditor, this is also called transfer by way of security. However, if the debtor pays back his loan after all, he also gets back the deposited collateral. The transfer of ownership by way of security is reversed.

That loan collateral is necessary for banks is illustrated by a study from 2017, according to which around 41 percent of Germans have already been insolvent at some time. Nevertheless, exactly 41 percent of the German population also find it okay to buy goods with borrowed money. So since loans are not always reliably repaid, banks need collateral. In Germany, banks are not yet legally obliged to take out loan collateral, but collateralization always means securing other customers. If it comes to an emergency, the financier can enforce his claim by means of an assignment of security or sell the security.

What makes a good security?

There are different types of loan collateral. A loan collateral is considered good if the bank can easily enforce the collateral and a sale in an emergency is promising. It should also be easy to value - because high valuation costs make loans more expensive and small loans unattractive. The following criteria should still be met by any type of collateral for a loan:

  • good exchangeability

  • Low potential loss of value during the credit period

  • Independence from the borrower's financial situation

What are the different types of loan collateral?

There are different types of collateral, for example securitized collateral such as a mortgage, a guarantee, a land charge or a general collateral claim. For small and shorter-term loans such as an overdraft facility, an abstract form of collateral is chosen: In this case, the lender receives a lien on all credit balances and assets deposited with the bank. In the area of smaller loans, the expected monthly income, which can be used as salary garnishment in the context of a claim, serves as a common form of loan collateral.

How does the security of a loan influence the interest?

With an interest margin of between two and four percent of the outstanding loan amounts, the most banks do not have much room for value adjustments on unpaid loans. Therefore the bank places the assignment of a credit on several, stable columns. In addition to a general assessment of the creditworthiness, which is based on past experience, the loan collateral serves as additional substance. This can then offer the borrower an even more favorable interest rate and risk surcharges are avoided.