Business News, Latest

How to Correctly Use Collateral to Secure a Business Loan

October 1, 2021
By Elizabeth Choice

You may be wondering how to correctly use collateral for securing a business loan. A simple way to look at it is that the bank takes the risk, and you take the reward.

Collateral is a loan that is secured by something of value, which can either be cash or an asset. Examples of collateral for a secured loan are real estate, stocks, bonds, and other valuables.

The notion of owning and operating your own company is one element of the American dream that seems to appeal to almost everyone. It’s only natural to be enthusiastic about eventually being your own boss, whether you’ve always dreamt of operating an Asian-Italian fusion restaurant downtown or just can’t wait to establish that charming little shop packed with your own fashion creations.

Understanding you’re ready to start a small or medium-sized company is one thing; knowing how to get the money you’ll need is another. Unless you’re fortunate enough to already have the money, you’ll almost certainly need to take out a company loan—and collateral is the backbone of every successful business loan application.

Let’s take a deeper look at the idea of collateral and talk about how you may use it to finance the company of your dreams.

Table of Contents

What’s the point of collateral?

A piece of property (typically physical) that a would-be borrower promises to a lender in order to assist secure a loan is referred to as collateral.

Having collateral essentially identifies you as a superior lending risk to banks and third-party lenders, and it opens the door to better loan choices that you may not have had access to otherwise. Real estate, vehicles, company goods, and even cash savings are common examples of good collateral.

Loans secured by collateral are usually calculated as a percentage of the item’s estimated market value. In today’s market, if you pledge a vehicle valued $20,000, a lender would most likely give you about 85% of that value ($17, 000). Collateral makes loans less risky for lenders while also demonstrating your commitment to repaying borrowed money.

In a word, collateral is your ticket to cheaper interest rates and a better chance of being approved in the first place.

What is the best way to use collateral to your advantage?

We suggest maintaining a comprehensive record of your assets to speed up the process of getting accepted for a business loan with security. There are many approaches to this, and a simple internet search will show a plethora of sophisticated software and services. In 90% of instances, we suggest keeping things simple: just enter asset information into an Excel spreadsheet, pass it over to your lender, and they’ll handle the rest.

In certain instances (for example, big, complex loans with numerous contract terms), keeping track of a large number of assets through Excel may not be the most efficient method. These scenarios usually require something more sophisticated than an Excel spreadsheet, such as software that tracks assets automatically based on current market pricing (Oracle is a popular choice).

Once you’ve compiled a list of your assets, you can show it to a potential lender, who will evaluate it using their own set of criteria to establish its actual worth.

What if you don’t have enough assets to back up your claim?

Is it better to quit up now, or is it still feasible to get a loan?

Yes, there are lenders that provide unsecured business loans (loans that don’t need collateral), but you’ll generally need to have excellent credit to qualify.

If this fails, your choices become limited. But don’t give up; if you look beyond the box, you’ll find that there are lots of alternatives open to you.

When it comes to screening lenders, search around for the most trustworthy companies with the lowest interest rates, and then apply online (if online application services are available).

Collateral may include valuable company equipment and machinery. Photo credit: Flickr.

Don’t guess; figure out how much your collateral is worth.

When it comes to collateral, one of the most frequent errors made by prospective company owners is overestimating its worth based on current market conditions.

Keep in mind that if you fail on your loan, the lender will have to expend resources to seize your collateral, find a buyer, and successfully sell it—not exactly a painless process! That so, it’s easy to see why banks are renowned for being cautious when evaluating a borrower’s collateral.

Playing guessing games with oneself is not a good idea: If you’re not sure how much your assets are worth, hire an appraiser who can give you an estimate of how much a bank would pay them and provide you with a report to show your lenders. You’ll want to keep personal records that show how much these assets are worth over time.

This reassures banks that you’re paying attention where it matters most. You may do it yourself using financial tools and resources intended for the purpose, or you can hire a professional financial adviser who can contribute to your knowledge and expertise.

Recognize the dangers as well as the alternatives.

When you utilize collateral to obtain a company loan, be sure you completely grasp what’s at stake: If you default on your loan, you will lose all of your possessions, including your house, vehicle, and savings. For this reason, you’ll want to be sure you’re only using property to which you have exclusive ownership.

If you don’t have enough collateral to obtain the loan you want, make sure you’ve looked into all of your options and don’t be afraid to be creative with your lender. Here are some non-traditional sources of possible collateral that you may use as an example to help you think beyond the box:

Jewelry that has been evaluated and certified as having a certain value
If your company is already established and has a number of open purchase orders, you may be able to borrow using them as collateral.
Business equipment and gear worth a lot of money

Prepare to present your ideas.

Approach the business loan application procedure in the same manner you would a client’s product presentation. Be prepared for a lot of detail. Are you establishing a new company in your neighborhood? Prepare to explain to your lender what that company will contribute to the community and how you plan to ensure its financial success. Are you trying to raise money for renovations or a second location? Expect to be asked to explain how your ideas will help your company become even more successful than it is now.

In other words, lenders want to see proof that you’ve given some consideration to how you’ll put this money to good use. A thorough, well-thought-out business strategy, as well as precise documentation where necessary, will go a long way.

Examine your options.

Once your applications have been reviewed by prospective lenders, you will begin to receive offers on possible business loans from those who are interested. Avoid the temptation to accept the first offer that comes in the door; taking the time to thoroughly evaluate all of them will have a significant effect on the final outcome.

Pay close attention to the loan-to-value ratios on the offers (remember that an average ratio comes out to about 85 percent of the value of the collateral.) You should also consider the overall length of the payback term as well as the interest rate.

If you’re unsure how to continue at this point, remember that you don’t have to make the choice alone! If you’re not sure whether or not a certain choice offers a good deal, consult a financial adviser before making a decision. Finally, particularly when collateral is involved, you don’t want to get left with a loan arrangement that isn’t fair to you or that would be difficult to repay.

Make banks compete for your business by making them compete for your business.

Consider consulting with your financial adviser about the worth of your collateral in relation to the rates you’ve been offered before accepting a particular offer. Then, when you’re ready, bargain for conditions that represent the real worth of what you offer to the table.

Banks and loan agencies are much like any other company. They make a significant part of their money by lending money to individuals like you. That said, if you’re a desired lending risk with a good cause for needing a business loan in the first place, they’ll want to make sure you do business with them instead of the lender down the street! Before you sign on the dotted line, take your time and examine all of your choices.

Wonderlane, Flickr, for the header picture.

The sba loan collateral eidl is a document that allows you to secure a business loan. This document is also known as the Small Business Administration Loan Agreement.

Frequently Asked Questions

What can be used for collateral to secure a business loan?

Collateral can be anything of value that is capable of being sold to secure a loan.

How do you secure a collateral loan?

A collateral loan is when you borrow money but you have something of value that you can pledge as collateral. The lender will then lend you the money and the value of your pledged asset is what they are willing to loan.