Collateral is something you own which has value.
Collateral, especially within banking, traditionally refers to secured lending (also known as asset-based lending). More recently, complex collateralization arrangements are used to secure trade transactions (also known as capital market collateralization).
The former often presents unilateral obligations, for secured in the form of property, surety, guarantee or other as collateral (originally denoted by the term security), whereas the latter often presents bilateral obligations secured by more liquid assets such as cash or securities, often known for margin. Some forms of lending are solely based on the strength of the collateral such as gold, jewelry and property. Certain non-conservative lending practices such as lending against antique items or art works are also known to exist.
Collateral assets come in many forms. Collateral is an additional form of security which can be used to assure a lender that you have a second source of loan repayment. Most commonly, collateral is real property (i.e. an owner-occupied home), but it can also be represented by your business’s inventory, cash savings or deposits, and equipment. In order to structure a loan that benefits both you and your business, you’ll need to make the right decision about what you offer up as collateral to the bank. It’s also important to be realistic when considering the risks of defaulting on a loan, which could have harsh consequences for not only your business, but for your personal life, too.
You cannot use something for collateral which does not yet exist or belongs to someone else – for example – future earnings, and/or property you intend to purchase after receiving a business loan. And it is commercial lenders who accept or decline your collateral. Just because you ‘think’ you have collateral to secure business funding, doesn’t mean that you do.
Banks are notoriously conservative about valuing a borrower’s assets for collateral. After all, if the borrower does default, the lender must expend resources to take the asset, find a buyer, and sell it.
Essentially, there are two different types of collateral: assets that you own, and assets that you still have a loan against. If you still have a loan on the asset, (e.g. a mortgage for a house) the bank will be able to recoup the loan by refinancing your loan from the institution you have the loan against, and claim the title.
Since the housing bubble burst, using real property as collateral financing took a huge hit. Asset-based lending can be a great way to get a fast influx of cash to your business. The advantage using cash as collateral is that you’re guaranteed a low interest rate because it’s a secured loan.
Accepting a business loan using personal assets as collateral presents the risks of losing the assets in the event that you default on the loan. Therefore, it’s important to discuss the risks of using certain assets as collateral with a financial advisor, as well as people that could be affected by the loss of that asset.
If you’re a qualified borrower with a demonstrable history of good business credit, you should be able to secure a loan with commitments you are comfortable with. Remember, a business can always reject a lender’s offer and seek a loan from a different lending institution.
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