Collateral
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What is Collateral?
Collateral is an asset that is accepted as security by a bank, for example, to secure a loan. There are a variety of collateral types that can be deposited for a loan, including real estate (mortgages) and shares (Lombard loans). As a result, collateral serves as protection for the lender. The lender may sell the deposited collateral if the borrower fails to meet his debt obligations. Consequently, collateral reduces the risk for the lender.
The type of collateral required for a loan is often determined by the type of loan. The collateral for a mortgage, for instance, is the house. In the case of a car loan, the collateral represents the vehicle itself. There is also the option of securing credit cards with a cash deposit equal to the credit limit. Generally, lenders accept collateral such as cars (paid off), savings and investment accounts, as well as fixed-income securities, stocks, and life insurance policies. It may also be possible to use future salary payments as collateral for short-term loans (up to a few weeks). Because the lender's risk is reduced, collateralized loans typically have a lower interest rate.
Types of Collateral
Lombard Loan
In the case of a Lombard loan, securities are deposited as collateral. The bank provides a loan based on a certain percentage of the securities portfolio (e.g., 80%). If the investment account consists of securities in the amount of CHF 1,000,000, CHF 800,000 (80%) could be lent. A problem arises if the value of the securities (collateral) falls abruptly, e.g., during a financial crisis. In such cases, the bank may demand more collateral (e.g., additional cash deposits or the deposit of additional securities) and if the additional collateral is not provided margin calls (forced sales) may occur. In good times, banks are willing to sell large Lombard loans. However, it is wise to consider the risks beforehand in order to avoid forced sales during an uncertain period. Such a situation can be avoided by seeking the advice of a good and independent wealth manager.
Mortgage
Mortgages are loans secured by real estate. The lender may take possession of the real estate through foreclosure, in case the homeowner fails to make mortgage payments. In order to repay the remaining loan balance, the real estate may be sold after it has been transferred to the lender.
Home Equity Loan
A house may also be used as collateral for a second mortgage or home equity loan. If this is the case, the loan amount cannot exceed the amount of equity available.
Land Charge
The security of a loan is provided by a property.
Personal Guarantee
This is a situation in which another person is responsible for paying back the borrowed funds. If the applicant's creditworthiness is insufficient, he or she may provide guarantors who are obligated to repay the remaining debt in the event of a default. A creditworthy guarantor is required in this situation.
Lien
Liens are secured by valuable movable tangible assets (e.g., jewelry) as collateral. Savings deposits and securities are also included in this category.
Transfer by Way of Security
Similarly to a lien, this involves movable tangible assets (e.g., a car). However, the borrower retains the right to use the collateral during the term of the loan, provided he does not default on payments. Legal ownership, however, remains with the lender.
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