If you need help financing your business goals, a
small company loan can give you the capital you need. But to get it, you may need to provide collateral.
Some lenders require collateral for their loans, especially if your business has limited or bad credit history. Even if you’re applying for a loan that doesn’t require collateral, you may still want to provide it because it can help you qualify for a better interest rate and terms.
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What is collateral?
Collateral is an asset or assets that a business owner promises to hand over to a lender if they fail to repay the loan. Collateral acts as security for the loan.
When you provide collateral, you reduce the risk that a lender has to leave empty-handed. Since the lender has this security, they are more likely to approve a loan and even offer better rates and longer repayment terms. Collateral can even help entrepreneurs with poor credit qualify for a loan.
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How collateral works
When you sign closing documents for your loan, you sign a lien on the property you use as collateral. This agreement clarifies the lender’s right to your property to recoup their costs if the loan goes unpaid. The collateral remains in your possession as long as you stay on top of your loan payments.
Lenders generally want enough collateral to offset 100% of what you are asking to borrow. The value of your property is assessed, usually in comparison to similar properties that have recently sold.
Assets are usually rated based on the stability of their value (for example, cars depreciate quickly; real estate, on the other hand, is valued over time). Marketability and transferability also play a role in assessed value: lenders prefer assets that can be easily transferred if necessary.
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If you need to catch up on payments, your lender will likely contact you before repossessing your collateral. Once your loan is paid in full, your lender must release you a lien, relinquishing any rights they had to the property under the terms of the loan.
Types of collateral
Here’s an overview of some common types of collateral.
If your business owns real estate, it can serve as collateral when you borrow. This type of asset can be a home office, other buildings, or land belonging to the company. Real estate is usually a strong form of collateral because of its size and stable value.
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Many types of equipment and machines can fall under this umbrella, including office equipment, semi trucks, and heavy machinery.
Lenders can be picky about this form of asset as collateral: the older or heavily used your equipment is, the less value it has to a lender. Likewise, if your equipment is niche to your industry and would be difficult for your lender to unload, it may be less valuable as loan collateral.
Unsold inventory can serve as loan collateral for your business. Particularly if you are in the retail business, you may find this a valuable asset to offer. As with specialized business equipment, lenders may find certain types of inventory more desirable than others, so be aware that your appraisal may differ from your lender’s.
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If your company owns stocks, bonds, or other investments, they are generally considered strong collateral. Like cash, these assets are easy to value and liquidate, so they’re ideal if you can tolerate the risk associated with using them to secure your loan.
Few lenders consider cash as collateral for the loan, but it’s the simplest asset you can offer. Business bank accounts, such as checks and savings, may be where you keep cash assets, in which case obtaining documentation should be easy.
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When you use an invoice financing company, you obtain a loan with unpaid or outstanding invoices. This type of business loan can be costly and you miss out on the opportunity to get the full value for your unpaid bills. But this is a quick way to secure financing, so you don’t have to wait 30, 60 or 90 days for an invoice to be paid.
A general lien is attractive to lenders, but very risky to borrowers. This type of collateral can give your lender broad authority to seize multiple assets if your loan goes unpaid, sometimes up to or including all of your business assets.
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Pros and cons of collateral
- It is possible to qualify for a secured loan with fair or even bad credit.
- Collateral can lower the rate or improve the terms of your loan.
- Can increase the amount you are eligible to borrow.
- Processing your application may take longer than with an unsecured loan.
- You run the risk of losing your collateral if you fall into payment arrears.
It boils down
If you can tolerate the risk of potential asset loss, offering collateral can be a great way to qualify for a loan you might not otherwise be able to get. Additionally, because lenders invest less risk in secured loans, they can offer better interest rates and repayment terms in exchange for the lien on your collateral.
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Frequently Asked Questions
How much collateral do you need for a business loan?Caret Down Generally, lenders try to secure your loan using collateral that is equal to (or greater than) the amount you want to borrow. Your lender may not value your collateral the same way you do, so be prepared to estimate only 80% or 90% of the fair market value of your assets.
Can you get a business loan without collateral?Caret DownYes, unsecured business loans are available. They may need a longer and stronger financial record and excellent credit to be approved, but not all loans require collateral.
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What are the pros and cons of asset-based lending?Caret DownAsset-based loans refer to a loan or line of credit secured by collateral. In general, secured loans and lines of credit offer more favorable lending terms for entrepreneurs and less risk for lenders than unsecured debt. Conversely, this type of loan generally requires more time and documentation than unsecured loans, both when taking out and after the loan is paid off. For borrowers, asset-based lending can be a risky gamble that jeopardizes their business operations.