Loan security: With the right security for the desired loan

Whether it’s a smart smartphone, a new car, or the dream of owning your own four walls – if you need a loan to finance it, you have to provide the bank with collateral. Some collateral is mandatory by the lender. Others can be provided additionally to obtain more favorable conditions.

Especially with larger loan amounts, but also with insufficient creditworthiness or creditworthiness, additional loan collateral is a prerequisite for obtaining a loan.

But what types of loan collateral are there, what advantages and disadvantages do they offer and what happens in the event of insolvency?

What is loan collateral?

Collateral or collateral is assets or title to assets that the borrower is required to pledge to the lender as collateral for a loan.

The bank can use this collateral to settle arrears or debts, for example, if the borrower does not pay the agreed installments or cannot repay the loan in full. Conversely, this means that the bank may only use the collateral if the borrower is insolvent.

Many assets can be used as so-called customary bank collateral. These include, for example:

  • income
  • savings balance
  • securities
  • property
  • life insurances

Which loan collateral the bank ultimately demands depends on various factors, such as the amount and term of the loan.

Why does the bank need collateral?

Banks need collateral to lend money. If a borrower does not repay their loan, the bank can lose a lot of money. The bank wants to minimize this risk of default with the help of loan security because unsecured loans can ultimately lead to bank insolvency or even to an overarching financial crisis.

The longer a loan runs, the more likely it is that the borrower’s creditworthiness will change. And that makes it all the more difficult for the bank to assess the default risk. Unforeseen private or economic events such as unemployment or divorce can reduce the debtor’s ability to pay. Long-term loans are therefore more strictly secured than short-term loans.

What are the requirements for loan collateral?

Banks prefer loan collateral with the following characteristics:

  • Easy to assess: The value of the loan security can be determined with little effort.
  • Low potential loss of value: The value of the collateral should remain stable over the term of the loan. For example, real estate makes better collateral than stocks, and a Mercedes is typically less volatile than a Fiat.
  • Can be used quickly: The loan security can be sold quickly and easily.
  • No direct economic connection: The security must be independent of the financial situation of the borrower and must not be contestable, for example in the event of insolvency.

What types of loan collateral are there?

Basically, a distinction is made between the following types of loan collateral:

Personal Collateral

security assignment

Real and physical collateral

assignment of claims

lien

  1. Personal Collateral

In the case of personal security, in addition to the borrower, another person is liable for the loan amount. The bank may approach this person in the event of payment arrears or impending payment default and demand that the debt is settled.

A frequently used form of personal security for private individuals is the guarantee. A guarantee is an option if the collateral and the creditworthiness or creditworthiness of the applicant are not sufficient for the desired loan. Then he can provide a guarantor. In the event of a loan default, the latter undertakes to pay for the outstanding balance instead of the borrower. Prerequisite: The guarantor must meet the creditworthiness criteria of the bank.

Parents or grandparents often stand in as guarantors for their children or grandchildren if they have little or no income and want to buy their first car, for example.

extra tip

Select the “Default Guarantee” variant. Then the guarantor is only liable at the moment when the enforcement process against the debtor has been classified as unsuccessful. In the case of the “direct guarantee”, on the other hand, the lender can immediately access the guarantor’s assets without prior process.

Advantage of personal guarantees

People you trust, such as parents, family members, or friends, can take over the guarantee.

The disadvantage of personal securities

The guarantor is fully liable for the outstanding amount. The bank may, under certain circumstances, seize his income or assets.

  1. Real or physical collateral

In the case of physical security, the borrower assigns property rights to the bank. Property collateral is, for example, valuable items such as a car, securities, or real estate. If there are payment difficulties, the lender may sell or compulsorily sell the physical security to cover the outstanding claim.

The mortgage and the land charge occupy a special position. They relate to immovable tangible assets such as residential property or land and are therefore classified as real estate liens. Both credit securities are entered into the land register by a notary for a fee. This secures the bank’s right to the property.

Since real estate has stable values, land charges and mortgages are suitable for securing long-term loans such as construction or real estate financing.

mortgage

The mortgage serves to secure a specific loan transaction. It is therefore taken up in the exact amount of the loan to be secured. With each payment, the amount of the mortgage also decreases. The mortgage expires automatically as soon as the loan secured by it is paid off in full.

advantage of the mortgage

You can use the property without restrictions.

the disadvantage of the mortgage

You may only sell the property with the approval of the bank.

land charge

In contrast to a mortgage, the land charge is not tied to a specific loan. The amount of the mortgage, therefore, does not have to match the amount of the loan to be secured.

Rather, the land charge can be ordered: “in advance”. If, for example, it is not possible to estimate the total costs that will actually arise at the start of a construction project, the land charge can be set up in such a way that it covers the largest possible loan amount that can be expected.

Another special feature: the land charge does not automatically expire when the loan is repaid but remains at its original level. As a result, it can be used again and again as collateral for further financing. However, it is possible to have the land charge deleted from the land register for a fee after the loan has been repaid. This requires the lender’s approval to delete the data.

extra tip

Since the cancellation of the mortgage usually costs a few hundred euros, you should check whether you should leave the mortgage and use it for a planned new loan.

All costs relating to the deletion of the land charge can be found in the article on the subject of land register costs 

advantage of the mortgage

The land charge can be used as security for further future loans.

the disadvantage of the mortgage

If the debtor defaults in payment, the fixed land charge can be attached without a prior court order. The creditor (bank) can immediately foreclose on the property.

  1. Lien

The lien relates to movable property. This includes valuable items (e.g. antiques, jewelry), savings, or securities. The bank receives the right of exploitation until the loan has been repaid in full.

Prerequisites for the right of lien are:

  1. The borrower (pledgor) and the bank (pledgee) must agree on the financial value of the physical security before the contract is concluded.
  2. The material security is to be handed over to the pledgee. Only then does he have a legal claim.

These requirements increase the workload for the bank. In addition, some valuables are difficult to sell and have to be stored especially. Because of this, they are reluctantly accepted as collateral. Instead, claims are usually used as collateral (see “Assignment of Claims” below).

Advantage of Lien

Wide range of things that can (theoretically) be pawned.

Disadvantage of Lien

Although the borrower remains the owner of the pledged physical security, it remains with the bank until the loan is paid off.

  1. Assignment by way of security

The security transfer or security agreement is similar to the lien on movable property. However, the borrower only hands over his property (e.g. the car) to the bank in trust.

The bank thereby becomes the legal owner of the physical security, but the right of use remains with the debtor. He can use the security to almost the full extent during the term of the loan. If the transfer of ownership is used as security for car financing, then the purchased vehicle can be used immediately – even before the loan is paid off.

Advantage of security transfer

You can use the physical security provided, even if it is financed by the loan secured with it.

The disadvantage of security transfer

Possible additional costs, since the lender can impose conditions on the value retention of the loan security (e.g. taking out comprehensive insurance for the car).

  1. Assignment of Claims

In the case of an assignment of claims, the so-called cession, you transfer your claims against third parties to the bank as loan security. Examples are receivables from the employer (payment of wages and salaries), the insurance company, receivables from savings accounts at other banks, and from building loan contracts or tenancies.

If the income is assigned as loan security, the bank may collect the arrears directly from the employer. With endowment insurance, the surrender value serves as security.

extra tip

Before you z. B. cancel the pension insurance or the home savings contract to reduce the loan amount through more equity, you should check whether an assignment of claims is cheaper. Your money can remain profitably invested as loan security.

Advantage of the assignment of claims

Can be used flexibly as loan security.

The disadvantage of the assignment of claims

If the endowment insurance is to serve as collateral for a loan, the insurer must agree to such use. A permanent employment contract is a prerequisite for the assignment of income.

Loan collateral – the conclusion:

Take care of the issue of loan collateral in good time before applying for a loan. At Commerzbank, the prerequisite for applying for a loan is your income. If you have any further questions, please contact one of our consultants. Make an appointment now.

 

Leave a Reply

Your email address will not be published.