When they lend you money, creditors take a certain risk - in life everything happens and it may turn out that you are not able to pay it back. That is why they use various mechanisms for protection against possible losses. Along with assessing your creditworthiness, they may require other guarantees that the loan amount will be repaid to them. Collateral on a loan is precisely such a guarantee. It can be in kind, i.e. in the form of various assets - your property, car, valuables, or monetary, in which case your bank deposit, for example, serves as collateral. Another option is personal collateral - through a guarantor, who undertakes to repay the debt if you are unable to do so. Such loans are called secured. Of course, there are products on the market that do not require any form of collateral - unsecured loans.

 

Secured and unsecured loans

Both types of loans have their own specific features and advantages, which you can take advantage of according to your personal preferences and financial situation.

Loans that do not require collateral are called unsecured loans. With them, the granting procedure is easier and faster. The creditworthiness of the applicant is of paramount importance, both for the approval of the loan and for its terms and conditions. Usually, unsecured loans are for smaller amounts and have higher interest rates compared to secured loans.

The reason for the more favorable conditions for secured loans - lower interest rates, higher amounts, longer terms - is the presence of a guarantee and hence the lower risk that creditors assume. However, the process of granting them is relatively complicated and slow, which comes from the need for the collateral to be evaluated and accepted by the creditor. If you have a lower credit rating and limited access to borrowed funds, secured loans, which provide more security to creditors, may be a suitable option for you. They allow you to improve your credit history by repaying your debt regularly. Before applying for a loan, it is important to objectively assess whether you can service your obligations. Otherwise, you risk not only losing the pledged asset, but also seriously undermining your credit rating.

When it comes to secured loans, it is important to be aware of the different types of collaterals in order to be able to assess how they affect the terms of the loan and to understand your rights and obligations as a borrower or guarantor for a loan.

 

Personal collateral on a loan: Guarantee

The guarantor of a loan is a third party involved in the contract with the credit institution who guarantees the repayment of the debt with all their assets if the borrower stops servicing their obligations. Although the guarantor does not benefit from the borrowed funds, they bear the same legal and financial responsibilities as the borrower. In Bulgaria, the process of establishing a guarantor is regulated by the Obligations and Contracts Act, taking into account the specific requirements of the Credit Institutions Act and the procedures of the relevant credit institution. The guarantee is formalized by signing a contract that regulates the rights and obligations of the guarantor.

 

-          When is a credit guarantee required?

Banks and other financial institutions may require the involvement of a guarantor as an additional guarantee for the debt repayment, for example in cases of larger loans. As a rule, this is a condition for granting a loan to applicants without a stable credit history, without sufficient evidence of regular income or seeking an amount that exceeds the usual amount relative to their income and financial profile. A guarantee may be required for short-term loans with high interest rates due to the increased risk of failure to service the obligation.

If you are looking for a guarantor, keep in mind that they must meet certain criteria of the credit institution, most often requiring stable income and a good credit history. Usually, close relatives are chosen as guarantors. In order not to expose them to the risk of financial difficulties, you must carefully and realistically assess your ability to service the debt you have taken on.

-          If you are considering becoming a guarantor

The desire to help a close person should not interfere with sound judgment. Consider whether they actually have the resources to handle the repayment of the borrowed amount and whether they have been responsible for their other credit obligations. Assess your own financial situation in terms of the possibility of servicing the loan if your close person does not. Pease note that if the debt is not repaid, the creditor may take legal action against you as a guarantor, initiate legal proceedings and seize your assets, including bank accounts, wages and other property.

Of course, you should familiarize yourself with all the details of the loan agreement in advance – amount, repayment period, interest, fees, penalty interest, other conditions, since this is a possible commitment on your part. Another important aspect of a guarantee is that it affects your credit history. Failure to fulfill obligations by the borrower leads to a deterioration in your credit rating and level of indebtedness, which in turn makes it difficult for you to access borrowed funds. And vice versa - if the debt is serviced regularly, then the guarantee has a positive impact on your credit history.

As a guarantor, you have legal rights in addition to obligations including the right to information about the credit agreement and the borrower’s financial condition of the, the right to compensation from the principal debtor through a recourse claim if you have paid the debt, the right to be notified in advance of any actions by the creditor that involve you financially.

 

Collateral

In general, collateral is a valuable asset on which the credit institution establishes a pledge (on a movable property) or a mortgage (on real estate) and may sell it to recover the borrowed funds if the borrower fails to meet their debt obligations. The value of the collateral is assessed by the lender to determine the ratio between the loan amount and the value of the asset. Often the amount granted is lower than the value of the collateral, which provides the lender with a higher degree of protection. The presence of a guarantee reduces the risk for the lender and leads to more favorable conditions for the borrower.

Collateral is usually required for larger loans such as:

-          Mortgage loans: A mortgage on a property is the most common case of collateral. It is used in housing loans for the purchase and/or renovation of a home, as well as in non-target consumer loans.

-          Car loans: When purchasing a car on credit, the car itself can serve as collateral.

-          Refinancing other debts: For larger refinancing amounts, a mortgage on real estate may be required.

-          Business loans: When the loan is intended for investment or operating capital, collateral in the form of machinery, equipment, inventory or real estate may be required.

 

As with all other credit products, regular servicing of obligations is of paramount importance. If you stop paying your debts, the creditor may take a series of legal measures to collect what is owed. They may initiate legal proceedings, resulting in your collateral, such as property or a car, being sold at public auction. The proceeds from the sale will be used to cover the debt. If these funds are not sufficient to cover the entire amount, you remain liable for the balance and the creditor can take further action to collect the debt.

 

Monetary collateral

Monetary collateral is an amount of money that borrowers hold on deposit with the lending bank as a guarantee for the fulfillment of their loan obligations. There are credit products that allow collateral to be accepted in the form of a deposit from a borrower’s close person. It is used by consumers who want to get better loan terms, such as a lower interest rate. Monetary collateral provides additional security for the lender and often facilitates loan approval. In the event of non-compliance with the contractual terms, the creditor has the right to use the deposited funds to cover the debt. This method is widely applicable to consumer loans, where the speed and ease of obtaining financing are a priority.

 

Useful links

Law on Obligations and Contracts

Law on Credit Institutions