Collateral, or an asset pledged by the borrower to the lender for the duration of the loan, is frequently used to secure business loans. The lender may take that collateral and sell it to recoup their loss if you do not make payments on time each month. Collateral is a tool used by lenders to lower their risk of loan loss. The amount of collateral required can vary depending on a number of variables, such as your credit score, the type of lender, and the kind of collateral. Some lenders permit or demand that applicants pledge personal assets as collateral for business loans. Learn more about the different collateral requirements.
What Can Be Used as Collateral for Business Loans?
- Valuable Assets
A valuable asset can serve as collateral, although not all valuable assets can serve in this capacity, and some types of collateral are preferred over others. From the lender’s perspective, the best collateral is anything that can be swiftly liquidated, or immediately turned into cash. Cash is therefore a good choice for collateral. Securities can also be used as collateral for loans, including Treasury bonds, equities, certificates of deposit (CDs), and corporate bonds.
- Tangible Assets
Real estate, equipment, stock, and automobiles are examples of property that can be used as collateral for business loans. These are all physical, tangible assets that may be owned by the company or its owner, or may have loans secured against them. Hard assets, on the other hand, could be more difficult to sell and have an uncertain value. To confirm the worth of your hard asset, you might need to have it appraised in some circumstances.
- Future Earnings
Another category of collateral includes future earnings, such as accounts receivable, which are bills that you have already sent out.
- Personal Assets
Some business loans demand that you put up personal assets in addition to corporate assets, which can be your house or car. In the event that your business does not have enough assets to offer the necessary collateral, the Small Business Administration (SBA) may impose this requirement.
Collateral Requirements for Business Loans
One crucial indicator that lenders use to determine the collateral they require is the loan-to-value (LTV) ratio. LTV is the sum that a lender will advance to you in relation to the value of the security. For instance, if you use real estate as collateral for a company loan, a bank might give an 80% LTV ratio. As a result, even though the property is worth $100,000, it will only lend you $80,000. The discount is the distinction between the fair market value of the collateral and the loan’s principal; in this case, the discount is 20%. The discount on highly liquid assets will be smaller. Normally, a borrower should provide collateral equal to the loan amount. To assist in mitigating their risk, certain lenders, however, could demand that the value of the collateral be more than the loan amount.
“The Five Cs,” which are typical measures of financial health can help determine how much collateral you need.
- Credit history
- Capacity for repayment
Conditions (interest rate, loan terms and amount)