How to Use Collateral to Purchase a Home

When you buy a home using a mortgage, your new home usually provides the collateral needed to secure the mortgage loan. But there are times when you need more than the down payment on the home to get that loan you need to make the purchase. Or, collateral may allow you to borrow more money, at less risk to the lender. It may also help you get a better interest rate on your mortgage. It may make it easier for you to get a mortgage in a competitive market, or give you the lower interest rate you need to make the payments fit your budget.

Collateral can vary widely. Usually, however, it’s something that a lender can easily convert to cash, so it must have value. Cars, real estate, cash savings accounts, machinery, investments, insurance policies and collectibles will often be accepted as collateral. If you are using a car or a collectible, you must be able to show the appraised value of the item. Retirement accounts typically do not qualify, although there are exceptions. If you already own a home or land, that may provide the collateral you need for a mortgage.

You can’t expect to get the full value of your asset as collateral. That’s to protect the lender in case the investment loses value. Lenders often use a loan to value ratio to determine the value of the collateral. It’s not unusual for assets to be valued at 50 percent or less of their appraised value. When collateral is used to secure a mortgage, you'll want its cash value to be about 10-to-20 percent of the home's value.

If you own a piece of land or have significant equity in a piece of land, it can be a good way to use collateral to buy a home. To start with, check your credit report and get your land appraised so you know how much it’s worth. Expect to get no more than 35 percent of the land value as collateral for your home.

You can borrow against your stock portfolio, taking out a securities-based line of credit or SBLOC. This loan uses stock, bond and mutual funds that you already own. These assets can be volatile, however, so proceed with caution.

When the market is good, your collateral has value. But if the market value drops, your lender may ask for more collateral on short notice. Also, the lender may sell as many of the securities as is needed, possibly without your input. However, there are ways to minimize your risk. Make sure you know the terms of the loan, your rights and how the repayment process works. Also, ask what the extra fees are. Borrowing as little as possible will also give you an extra cushion, in case the value of your portfolio should unexpectedly drop.

Remember that when you use equity for a down payment, you will need to start repaying the loan immediately. So when you consider the cost of buying your home, remember to add this payment to your monthly budget so you don’t lose your investment. Also, if you are building your house, remember there can be construction delays and cost overruns, so factor those into your monthly budget.