A very important thing to know about mortgages is the concept of ‘collateral’. Yet, mortgages can be very complicated if you don’t know much about them.
Whenever you get a mortgage, you will almost always need to put up a form of collateral as a guarantee that you will pay back your debt. When you take out a mortgage your home becomes the collateral. Lenders love this, as this is the best form of collateral – your actual home!
What is Collateral?
You must be wondering, what exactly is collateral? The concept of ‘collateral’ is simple to understand. Look at it as an “asset” that the lender will take as security for their loan. Collateral can be any type of asset. With respect to mortgages, the collateral is real estate (ie: your home). If you are buying an income property and getting a mortgage for the income property, your collateral becomes the actual investment property.
Collateral is really a form of protection for the lender. If you (the borrower) stop making your mortgage payments, the lender can take the collateral (your home) and sell it in order to make back some or all of their losses.
WHEN YOU TAKE OUT A MORTGAGE YOUR HOME BECOMES THE COLLATERAL.(IMPORTANT THINGS TO REMEMBER)
- Collateral has value and it is used to secure your mortgage.
- Collateral is used in order to reduce risk for lenders. Lenders don’t like risk and they want to reduce it.
- If a borrower stops paying, the lender can take the asset and sell it in order to make up some or all of their losses.
Final Thoughts
When you take out a mortgage your home becomes the collateral. This is really done in order to protect the lender. The concept of collateral can sometimes scare people, but you need to remember that as long as you make your payments, you have nothing to worry about. Even if you do fall onto some hard times and miss some of your payments, many lenders have programs in place in order to help you get back on track so that you do not lose your home. Please do not be fooled though, you do not want to voluntarily fall behind on your payments.
Lenders take collateral so that they can offer lower interest rates. They feel safe lending out large amounts of money (mortgage) because it is secured by your home (real estate).