Collateralfor Business Loan Examples & Types that are Accepted
Bank loans, commercial loans, or bank borrowings are loans specifically made by companies to fund their business operations and/or their business plans to use for future investments and other endeavors that are designed to benefit the business.
These loans are typically secured by something known as collateral.
Collateral is an asset possessed by borrowers as an assurance or security to the lenders they are indebted to which is equivalent to the amount of cash they intend to borrow.
If a borrower fails to pay the loan, the lender can take possession of the collateral and sell it to settle the loan.
Generally, collateral is required by lenders to minimize the risk of losing their money when borrowers fail to pay the amount owed.
The type of collateral needed by lenders is based on several factors such as:
- The creditworthiness of the borrower or their ability to fulfill the obligation;
- The type of lender the borrowers will borrow from and;
- The classification of collateral that will be pledged.
There are cases when lenders will require personal property, resources, or assets to be used as collateral to secure the loans needed by the business.
To learn more about the collateral used for business loans, examples of those collateral, and types of collateral that are generally accepted, we are going to answer and discuss the following questions:
- What qualifications need to be met in order for certain collateral to be accepted for securing a business loans?
- How much collateral is needed to secure a loan?
- What types of collateral are needed for each type of business loan?
- What are some of the most common questions regarding business collateral?
What qualifications need to be met in order for certain collateral to be accepted for securing business loans?
As mentioned previously, collateral are assets and every asset acquired by the business has a corresponding monetary value attached to it, which is why it can be used to settle loans.
Despite this, not all assets can serve as collateral.
There are also scenarios where certain collateral is preferred over others.
From a lender’s perspective, the best collateral is an asset easily liquidated or convertible into cash.
Hence, the most promising collateral is cash.
Other assets that can be used as collateral are marketable securities, stocks, treasury bonds, certificates of deposit (CDs), and corporate bonds.
These assets are characterized by their nature of being easily liquidated.
Real estate properties, equipment, inventories, and vehicles are some of the tangible or physical assets used by companies to secure business loans.
Since these assets are either personally owned by the owner of the business or owned by the company itself, these assets can be used by the lender to settle the unpaid financial obligations the business or its owner incurs.
To put it in another way, physical or tangible assets can serve as collateral too.
Although it should be noted that the conversion of hard assets into cash is not instantaneous, as it can take a lot of time and paperwork when attempting to sell large or high value assets.
Aside from that, the price of these assets is subject to change depending on several factors such as how much the asset has depreciated, the current market value of the asset and any defects or the like that can further affect the price of the asset in question.
Therefore, to verify the actual value of hard assets, some lenders would require an appraisal to be conducted on the business’ properties before accepting them as a valid collateral.
Another type of asset which can be used as collateral is the future earnings of a business which includes the company’s accounts receivables.
Accounts receivables are resources owed to the business that have not been collected yet such as cash or cash equivalent payments that have not yet been received.
Future earnings also include whatever invoices have been billed to the company’s clients or customers.
The Small Business Administration (SBA) may require personal assets – like your house and car – along with your business assets as collateral to secure the commercial loans they extend to you.
Usually, the Small Business Administration would need both personal and business assets at stake if the assets of the company alone cannot satisfy the amount of collateral needed.
Can a company obtain business loans without collateral?
Yes, a company can obtain a business loan without any collateral involved.
Usually, in the absence of a collateral, the ability of the borrower to pay his or her debts – also known as the borrower’s creditworthiness or credit rating – is what the lenders would examine and evaluate.
The lenders would also want to see how long the company has been operating for.
In addition, lenders will also look at the consistency of the business to establish and maintain emergency cash funds.
As it stands, the financial performance of a business as a whole is also important to lenders.
Hence, business loans without a collateral, which is also referred to as an unsecured loan, are available as well.
How much collateral is needed to secure a loan?
To answer this question, a lender would have to compute the loan to value (LTV) ratio.
A loan to value ratio (LTV) is a vital measurement that lenders use to calculate how much collateral is needed to satisfy the loan in the event that the borrower has to default or cannot pay.
Simply put, the business loan is based on the value of the collateral presented.
To illustrate this: a loan institution, the most common of which is the bank, would require an 80% loan to value ratio for a business loan if you offer a real estate property as collateral.
This means that the bank will lend you $80,000 if the collateral is worth $100,000.
The discount, also known as the “haircut”, is the difference between the fair market value (FMV) of the collateral and the amount of the business loan.
Based on the given example, the discount or haircut is $20,000, which is $100,000 less $80,000.
Assets that are easily disposable or very liquid will produce smaller haircuts.
It is customary for borrowers to offer collateral that has the same value as the amount they want to loan.
However, to lessen the risk of lenders losing money, lenders would require a higher collateral value than the amount the borrowers will ask for.
Borrowers would have to honestly assess their own financial status if they want to know how much collateral a lender will require.
“The Five C’s”, as it is known in the industry, are the common determinants of the borrower’s financial performance.
The Five C’s are as follows:
- Character of the borrower or their credit history
- Capacity of the borrower to repay their obligations
- Capital of the borrower or how much money the borrower has
- Collateral of the borrower
- Conditions of the loan referring to the interest rate, the terms of obligation, and the principal amount of the obligation
The indicators previously mentioned are individually examined by the lenders or creditors.
What this means can be demonstrated in the following scenario: if the borrower is only financially fit and capable, the Small Business Administration (SBA) will not outright reject a borrower’s loan application solely on the grounds of not satisfying the conditions of the collateral.
In other words, just because a borrower does not meet all of the five indicators, it will not always mean that their loan application would get rejected right away.
What are liens and why do we have to watch out for them?
A lien is what permits a lender to bring a borrower to a court of law when the borrower fails to fulfill his or her financial obligation.
A lien could either be general, also known as a blanket lien, when all types of assets are collateralized.
A lien could also be specific when it is attached to certain assets only like a building or equipment.
Blanket liens are more favored by lenders since all assets can be used to fulfill the loan.
It should also be mentioned that blanket liens can produce better terms and interest rates for the lender.
What are the collateral needed for each type of business loan?
The table found below will summarize the collateral needed for each type of business load.
|What is the type of business loan?||What is the kind of collateral needed?||What is the general Loan-to-Value (LTV) ratio?|
|1||Small Business Administration (SBA) Loan||General Type:||Real Estate Properties||Up to 90%|
|Personal Assets, in certain cases.|
|2||General Purpose Loan||General Type:||Not needed/required.||80% or lower than 80% is the general ratio. Higher than 80% would indicate a risky loan for lenders.|
|Other Types:||Most but not all types of collateral are acceptable.|
|3||Commercial Real Estate Loan||The property that was purchased or bought, developed and/or even remolded.||For SBA loans, up to 90%|
|For bank loans, up to 80%|
|For hard-money loans, up to 60% – 80%|
|4||Equipment Financing Loan||The equipment itself.||Up to 100%|
|5||Inventory Loan||The inventory itself.||Up to 50%|
|6||Accounts Receivables and Invoice Financing Loan||The future earnings itself.||Up to 80%|
|7||Peer to Peer Loan||Typically, collateral is not required or needed.||N/A|
What are some of the most common questions regarding business collateral?
Some of the frequently asked questions regarding business collateral are as follows:
- What is an acceptable collateral for business loans?
- Are collateral and personal assurance or guarantee the same thing?
- Is it possible for me to apply for a business loan without any collateral?
For the first question, the best collateral is cash due to its highly liquid nature.
Other acceptable collateral that is also liquid are marketable securities such as treasury bonds, stocks, certificates of deposit (CDs), and corporate bonds.
Physical or tangible assets like real estate properties, equipment, and inventory are generally suitable as collateral.
Accounts receivables and sales invoices are other forms of assets that can be used as collateral.
As for the second question, a collateral and a personal assurance or guarantee are not the same thing.
As mentioned earlier, a collateral is an asset used for securing business loans while a personal assurance or guarantee is the concept that requires the indebted – whether they are a business owner or not – to be personally liable for their own financial obligations.
And as for the last question, yes, it is possible to apply for a business loan without collateral.
Business loans that do not have any collateral are known as an unsecured loan.
From the perspective of the lender, granting unsecured loans is quite risky.
For this reason, borrowers tend to have difficulty obtaining these kinds of loans since higher interest rates and loans to value ratios will be present.
The challenging requirements expected from the borrower is to compensate for how risky it is for a lender to provide an unsecured loan.
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