Collateral is an asset or property that a borrower offers to a lender as security for a loan. It is used to secure loan repayment if the borrower fails to meet the terms of the loan agreement. Collateral can include real estate, vehicles, stocks, bonds, and other personal property. The value of the collateral must be equal to or greater than the amount of the loan for it to be accepted by the lender. Depending on their policies and risk appetite, different lenders accept different types of collateral. Businesses often use collateral to increase their approval chances when applying for business loans.
9 Types of Collateral that can Secure a Business Loan
Collateral requirements differ among various creditors. Moreover, one can choose their business loan collateral according to their preference, the amount of money required, or available resources. Below are the different types of business credit warranties available:
1. Real Estate Collaterals
The frequently used business loan collateral is real estate. Most moneylenders prefer this collateral because its value is high and does not depreciate rapidly. Examples of such securities include your home or lands. Borrowers seeking to invest in real estate need to understand that failure to repay the due amount leads to a shift in the legal ownership of their property to the creditor. Therefore, it is not wise to commit to a property that one is not ready to lose. The various real estate collaterals include mortgage notes, asset security interest, lease allotment and charge in property, and personal guarantees.
2. Company Vehicles Act as Loan Security
One can also use their car to acquire a secured business loan. Vehicle collateral improves a person's credit score with a bad credit history. However, the borrower needs to have equity in the vehicle. Equity is the difference between one’s assets and the amount they are obliged to. Positive equity increases the chances that a person gets the credit. For instance, if a car’s resale value is $10,000 and the owner still owes a car loan of $3,000, the equity is $7,000. It means that the equity is positive because the vehicle has more value than the loan owed. One of the drawbacks of this collateral is that its value decreases with time.
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3. Valuable Business Equipment
Companies can get secured business loans from lenders using their machinery as security. However, creditors do not accept all equipment for a business collateral loan. There are factors that a creditor considers while giving out collateral options. First, the price matters less than the value. Some machines might be costly but outdated. Therefore, a property that costs much but lacks a buyer is worthless to the moneylender. Additionally, other apparatus, such as computers, depreciate quickly, and a lender might not accept them as security. However, if the credit amount is low, the creditor might consider using such property as collateral.
4. Inventory Collateral
Another common collateral that secured business loan creditors take is inventory. Loans acquired through inventory collateral help enterprises maintain their stock and protect them from the damage caused by financial fluctuations. If one fails to clear their loan, they lose their inventory and may not maintain their business finance and generate sales. Additionally, the amount of money one receives from a creditor depends on the value of their inventory. Like any other business loan collateral, an inventory’s value determines the money lent by the creditor. The higher the value of an inventory, the greater the loan that a borrower can access. The financing is common to medium retailers and wholesalers.
5. Late Payment Invoice
Invoices can also serve as secured business loan collateral, especially for small businesses. Waiting for invoice payments can inconvenience small business owners. However, one can use them as a security to acquire money faster from a lender. When the time to repay the money comes, the creditor will collect the unpaid invoices. However, the investment will receive less than the amount if it fetches the money itself. The expenses come from the costs that involve the processing of the invoices. Nonetheless, the credit saves a business the losses that would occur due to the delayed fund disbursement.
6. Personal Investments
Investments like stocks can also act as a security for a business loan. The benefit of stock when borrowing a loan is that it increases one’s creditworthiness. The higher the stock, the greater the loan amount accessed. However, one disadvantage of using stock as collateral is its value fluctuates. Therefore, if the value falls below the borrower’s loan amount, they risk landing in trouble with the creditor. For example, the lender will demand more money to compensate for the deficit. Nonetheless, not all personal investments guarantee loan security. Some retirement savings accounts are not eligible for collateral.
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7. Blanket Lien
A lien is a legal power a moneylender gets to sell a debtor’s property to restore their money. A blanket lien is mostly accepted when a moneylender wants to risk giving a loan to a borrower with a low credit score. In such cases, the creditor asks the borrower to commit multiple properties. It increases the creditor’s potential to recover the money if the borrower fails to comply with the payment terms. Like all other collaterals, a blanket lien does not protect the borrower. It is only meant to cover the creditor from the losses caused by a failed loan repayment.
Cash is among the most specific and direct secured business loan collateral. One can use the money in their accounts or business savings accounts. Unlike other loan securities, cash collaterals do not involve additional physical property. Also, the amount the creditor lends depends on the amount of cash available in a borrower’s account. If a debtor fails to repay their loan, they will lose their cash to the creditor. However, this collateral is advantageous because the loan takes a short processing period and attracts a low-interest rate. Moreover, the creditor resolves a pending debt immediately because the process does not involve property auctioning.
9. Personal Assets
Although not all lenders recommend using their property as loan security, some may make one pledge their private assets. Personal properties are best used as collateral when the borrower has no other option. One should first think if they can live without their assets before committing them. Various valuables at home could help one get a loan, and they would not cause much pain if lost to a creditor. However, personal assets may guarantee a limited amount of money borrowed because some assets’ values depreciate after a while. Other properties involved in this loan security include jewelry and ornaments.
Should Every Business Loan have Collaterals?
One may ask, “Can I borrow loans even if I do not have an asset to commit?” Yes, there are unsecured loans that a borrower can acquire without collateral. The lender only checks the debtor’s credit score to determine the amount of money they can access. Furthermore, this type of loan puts the creditor at a high risk of loss. The credit usually has a higher interest rate than the secured business loans to compensate for the risk.
Moreover, unsecured business loans come in small amounts. For instance, novice or small businesses that do not have a business savings account can benefit from these credits. Examples of unsecured loans include the current online and mobile application loans. Creditors nowadays lend cash through these applications. The borrowers can acquire money without meeting with them physically or pledging an asset. One can acquire loans without collateral, including student loans, credit cards, and signature loans.
Choosing the Right Lender for Your Needs
Whether choosing a secured or unsecured loan, people find it crucial to find a business-friendly lender. Therefore, before applying for a business loan, most people compare all the available lenders. Some people found out that making a comparison helped them to find the best business loans. They compared loan terms, including the rates and penalties for delayed repayment. Furthermore, the annual percentage rate and monthly payments help determine whether the repayable amount will suit your investments’ income.