If you’re looking for extra funding for your business, this might be the most important article you’ll read today.
If you’re looking for funding to expand and grow your business quickly, this might be the most important article you’ll read today.
And here’s why:
Since there are various types of collateral for business loans with different advantages and disadvantages, you might need guidance from a qualified source about which option to choose to get the biggest business loan and extract the most benefits from it.
One problem you might encounter is that some lenders might require you to put down collateral to secure the loan.
Fortunately, with over two decades of experience as a financial coach and banking expert, I can guide you in picking the best type of collateral to help you secure that business loan!
Secured loans often require collateral to reduce the lender’s risks.
Collaterals can help get that secured loan, but they are not required for all lenders.
If you’re considering taking out a loan, it’s important to know the different types of collateral and how they can impact you and your business.
What is Collateral?
First, what even is collateral in business loans?
Collateral is a valued item pledged as a safety net or added security measure to help secure a loan.
Loans requiring collateral, or secured or asset-backed loans, usually have lower interest rates than unsecured ones.
All secured business loans need collateral, regardless of the type of loan you’re applying for.
However, some lenders may allow some businesses to get secured business loans without pledging any collateral based on their business credit profile and history but with higher interest rates.
Assets used as collateral must be the business’s property or the business owner’s or borrower’s personal assets.
Collaterals should have a high loan-to-value ratio, not have been pledged to other loans, and have no claims against them.
But loan collaterals can be anything. It can be real estate, equipment, stocks, inventory, etc.
If a business fails to repay the loan, lenders now have the legal right to collect the agreed collateral and sell it to regain their losses.
How Does Collateral Work?
Most small business owners don’t have enough funds to pay for an expansion or buy large or expensive equipment that can help their business grow — so they try to take out loans.
However, traditional banks and lenders are hesitant to lend money to businesses without some kind of guarantee that they’ll repay the money owed.
That’s where collateral comes in handy for lenders.
Offering collateral like real estate, vehicles, and more will tell your bank they can take the collateral and sell it to recover losses if you can’t repay the loan.
The value of the collateral will be based on the asset’s current market value.
Also, your loan amount will be based on the value of your collateral. For instance, if you’re looking for a $15,000 loan but only have $10,000 worth of collateral, the bank may only be inclined to lend you a $10,000 loan.
Types of Collateral for a Business Loan
Business owners benefit greatly from loans as they can help fund an expansion, finance their business operations, or buy new equipment.
However, getting that loan approval might require you to pledge an item of value.
Below are six types of collateral you can use to secure a business loan.
1. Real Estate
First on the list is real estate.
Real estate or home equity collateral is a property you own, such as homes, buildings, or commercial lands.
It is one of the most common types of collateral used for a business loan since home equity is easily attainable to most entrepreneurs or business owners.
Lenders also like real estate as collateral since it usually has high value with low decline risks.
Lenders can take ownership of your real estate and sell it to recover losses if you cannot repay the loan.
So, if you plan to use real estate as collateral, choose the one with the least value for you but can still back up the amount you’re trying to loan.
2. Business Equipment
Another type of collateral you can use to get that business loan is offering business equipment.
Business equipment as collateral is generally low-risk, especially for construction or manufacturing businesses.
You can offer simple equipment, such as computers, laptops, printers, and more, to support your loan amount.
Lenders could ask for the equipment’s receipts to evaluate its value.
Since this type of collateral is less risky than offering your family home as collateral, you might only get a small amount of loans from lenders.
3. Inventory
Inventory as collateral will only work for business owners in the retail or e-commerce fields.
Items in your inventory can be used as backup payments if you cannot repay the loan.
If your lender is unfamiliar with your inventory, they might ask for a third-party auditor to assess the proper value of your collateral.
They will also consider the liquidation value and future depreciation of the inventory.
4. Invoices
Businesses, particularly construction companies, have to compete with outstanding invoices and late payments.
This now causes cash flow issues, which require additional funding from these companies.
Fortunately, some lenders will still approve your loan application in exchange for a claim to your business’s outstanding invoices.
This can be a great alternative to acquiring that much-needed cash way faster than waiting for your clients to pay you.
However, lenders will still charge fees or interest, meaning you’ll have less money than if you wait for your client’s payment.
5. Cash
Banks and other traditional lenders prefer cash as collateral as it’s the most liquid asset a person can offer.
Lenders wouldn’t even need to go through the hassle of selling your asset to recover losses.
Cash as collateral for a business loan will come from the extra money you have from your bank accounts, whether from your business or personal account.
Now, you can benefit from low-interest rates and higher loan amounts (depending on your bank balance).
6. Investments
Investment collaterals such as stocks and bonds can be used for business loans or other lines of credit.
Similar to cash, investments are liquid assets that can easily be sold to repay lenders.
Investments are not popular with FinTech lenders; they are commonly used as collateral at banks.
However, the value of the investment collaterals can fluctuate depending on the market, which can become a problem if your investments’ value declines below the amount of loan you borrowed.
Can You Get a Business Loan Without Collateral?
If you plan to take out a loan but don’t have any collateral to offer, don’t worry; you can still qualify for a business loan!
Lenders will take a bigger risk if you seek a business loan without collateral.
If you offer no collateral, some lenders might not be willing to work with you, limiting your choice of lenders.
You’ll also need to have better credit to qualify. Many lenders, especially traditional lenders such as banks, require a good credit score to get approved for a business loan.
Lastly, interest rates will be higher, and loan terms will be much stricter if you don’t have collateral.
Benefits of Using Collateral for a Business Loan
Offering collateral might be more risky for business owners, but it can provide many benefits for borrowers.
A few advantages of using collateral for a business loan are:
- Get lower interest rates
- Have lenient loan terms
- Higher funding loan amounts
- Longer repayment schedules
- Fewer requirements
Using collateral gives lenders extra protection, lowering risk and translating into better terms for business owners.
Which Type of Collateral Works Best for You?
No type of collateral fits all businesses.
Every business is unique, and only you, as the business owner, will know and decide what type of collateral is best for you.
However, a good place to start is to consider what assets are available to you right now. Write down a list of pros and cons to help you evaluate your assets.
Do you have real estate, an extra vehicle, or business equipment that you never use? Is putting these assets up for collateral worth the risk?
Choose one that will have the least personal value for you.
Finally, you must ensure the collateral’s value matches your loan amount.
Should You Offer Collateral to Get a Business Loan?
Are you unsure whether or not you should offer any collateral to secure a loan?
Well, it will depend on your business.
Some business owners may not have enough assets to pledge as collateral, and others may be uncomfortable with the risk involved.
That’s why many businesses choose unsecured loans, which do not require collateral but are based on other factors such as credit or interest rates.
But if you have enough asset value, collateral can help you secure funding and qualify for better rates and terms.
Types Of Collateral For Business Loans: Summary
Many startup or small business owners lack the funds to expand or grow their businesses, so they opt for loans.
However, secured loans will require collateral.
Collateral is an asset that business owners offer to lower the lender’s risk of lending their money.
If business owners are unable to pay back their debts, the lenders will now have the right to seize their collaterals and sell them to recover losses.
There are many types of collateral for business loans. For instance, you can offer real estate, such as your home or other properties that you own.
You can also put up business equipment, inventory, invoices, investments, and more.
However, you’ll need to thoroughly evaluate your assets since the collateral’s value should be high enough to cover your loan amount.
Offering collaterals can help you get the best rates and less strict terms that can benefit your business in the future.