Business loans are often secured with collateral, an asset that the borrower pledges to the lender for the life of the loan. If you default on your loan, the lender can seize that collateral and sell it to repay the loan.
Lenders use collateral to reduce the risk of losing money on the loan. The amount of collateral needed varies based on several factors, including your credit rating, the type of lender and the nature of the collateral. Some lenders will allow or require borrowers to pledge personal assets to secure a business loan.
What is used as collateral for a business loan?
Collateral is an asset that has value – but not all assets can function as collateral, and some forms of collateral are favored over others. The best collateral (from the lender’s viewpoint) is an asset that it can liquidate quickly, meaning the asset can be easily converted into cash. Therefore, cash is favorable as collateral. Securities can also serve as collateral: Treasury bonds, stocks, certificates of deposit (CDs) and corporate bonds can all be used to secure a loan.
Property that can be used for business loan collateral includes real estate, equipment, inventory and vehicles. These are all tangible hard assets that could be owned by the business or the business owner, or have loans against them . However, hard assets may require more work to liquidate, and their value is less certain. In some cases, you’ll need to get an appraisal of your hard asset to verify its value.
Some business loans require you to pledge personal assets – such as your home or car – in addition to business assets. The Small Business Administration (SBA) may require this if your business doesn’t have enough assets to provide the collateral required.
Business loans without collateral
Unsecured loans are available to some businesses, too. These are loans that have no collateral requirements and are based on the creditworthiness of the small business borrower. Lenders typically look at personal and business credit scores, as well as the business’s overall health, time in operation and regular cash reserves.
How much collateral do lenders require?
Loan-to-value (LTV) ratio is a key metric lenders use to ount a lender will loan you based on the value of the collateral. For example, a bank might offer an 80% LTV ratio for a business loan if you pledge real estate as collateral. That means it will lend you $80,000 when the property is worth $100,000. The difference between the collateral’s fair ount of the loan is called the discount, sometimes known as a “haircut” – in this example, the haircut is 20%. Highly liquid assets will have a smaller haircut.
Typically, a borrower should offer collateral that matches the amount they’re requesting. However, some lenders may require the collateral’s value to be higher than the loan amount, to help reduce their risk.
- Credit history
- Capacity for repayment
- Conditions (details like interest rate, loan terms and amount)
Different lenders will approach these factors in their own way. For example, if you aren’t able to meet the collateral criteria but have an otherwise qualified application, the SBA won’t decline your application based on the lack of collateral alone.
Look out for liens
A lien allows lenders to take a defaulting borrower to court. Liens can be either generalized ones that collateralize all assets of the business – known as blanket liens – or only attached to specific assets, such as a building or piece of equipment. Blanket liens are preferred by lenders because multiple assets can be used to satisfy the loan, and these liens might result in better loan terms and rates.