Applying for a business loan can be an important step in helping your business grow. Deciding how much you need to borrow is the first step as well as what you will spend the money on to push your business forward.
Research needs to go into business loans such as who the best lenders are in your area for your particular requirements. All this is before you even start the application process.
Yes, it can be challenging trying to acquire a business loan. Choosing the right loan for you and researching the annual percentage rate and repayment terms can be time-consuming and complicated.
In addition to the research and certain documentation, your loan may require collateral.
You might be familiar with the term collateral if you have taken out loans in the past but if you are not, we are going to guide you through what collateral is and what can be used as collateral for a business loan.
Fortunately, the concept of collateralizing loans is not that complicated. Just think of it as another patch of the finance tapestry.
Continue reading to find out more about what collateral is, what you can use as collateral, and why it is needed when taking out a business loan.
Collateral: What is it?
In short, collateral is an asset that can be used to secure a loan. It is there to reduce the risk of lending to small businesses.
Sometimes, a borrower may not be able to make their loan payments. In this instance, the collateral can be taken and resold to cover the remaining cost of the loan.
By putting something of value up as collateral, it shows the lender that you are prepared to pay your loan in full.
Starting a small business can be risky but lenders who loan money to businesses are at just as much risk. Business can be tricky. There are good times and bad times.
While most business owners are prepared to pay back their loans, they can sometimes fall on hard times. Therefore, their loan repayments become impossible.
On occasions, some devious borrowers plan to take out a loan and have no intention of ever paying it back. Due to such circumstances, a lender can protect itself with collateral.
You may think collateral only benefits the lender but it can be advantageous to the borrower too.
By pledging collateral, business owners show the lender that they are prepared to keep up with loan payments and they are not high-risk borrowers.
When offering collateral, it can lead to reducing interest rates leading to the possibility of a more affordable loan.
Business owners can also open up more financial avenues with collateral. These include securing loans they may not have qualified for otherwise and acquiring higher loan amounts.
What can be used as collateral for a business loan?
Policies differ from one lender to the next. This includes policies on what type of collateral can be used to secure a loan. Nonetheless, anything that is of value can generally be used to back a loan.
When it comes to business loans, the borrower could lend a few thousand dollars up to a few million depending on circumstances.
For such loans, business assets such as equipment, supplies, buildings, vehicles, and inventory can be used as collateral.
Money owed to the debtors (accounts receivable) can also be used as collateral for loans.
If a business asset has value, it can be sold by the lender to pay off the loan if required. Any asset such as this is considered collateral.
Some typical examples of collateral for small business loans include:
- Real estate
- Business equipment
- Business inventory
- Future sales
- Cash reserves
- Accounts receivable
For the majority of business loans, the lender may require a personal guarantee as well as collateral.
If a personal guarantee is signed by you, your personal assets such as real estate, vehicles, or personal cash reserves can be seized to repay if you default on the loan.
Some loans may ask business owners to pledge specific assets. Other lenders may require a blanket lien. This gives the lender the right to all of the borrower’s business assets.
For instance, a lender has the right to seize the borrower’s business property to pay off the debt if the borrower goes into default. Any business asset can be seized to repay if the borrower defaults on the loan.
At least this way, the lender still gets paid even if the borrower stops paying on the loan.
Is it possible to get a business loan without collateral?
This generally depends on a variety of factors such as the amount of the loan, what the particular loan is, the credit of the borrower, and the specific policies from the lender.
If you take out an installment loan of a smaller amount, specific collateral is not required. Furthermore, business loans such as lines of credit, short-term loans, and credit card loans do not require collateral.
On most occasions, however, even if the lender does not require collateral, they usually need a personal guarantee to hand out business loans.
As we mentioned above, signing a personal guarantee acknowledges that the borrower will be held personally responsible for the repayment of a loan.
The personal guarantee is usually signed by anyone who has a 20% or more stake in the business.
This guarantee means that personal assets can be seized to pay any debt owed if the borrower defaults on their loan.
It is possible for the lender to take legal action if required. Such instances could see missed payments, late payments, collections, or defaults appear on the borrower’s personal credit reports.
Some business loans may require a UCC-1 blanket lien. A lien gives the lender the legal right to seize the borrower’s assets if the loan is not repaid. This can include a portion of their assets or all of them.
Your loan contract will establish the collateral requirements, personal guarantees, and blanket liens but before you sign, you must ensure that you understand the collateral policies set out by your lender.
Research beforehand can make life easier down the road. Even if you intend to pay back the loan in full, businesses are uncertain so you should cover all bases before signing anything.
How much collateral is needed to secure a business loan?
Many factors determine the amount of collateral needed to secure a business loan. These include:
- The amount you want to borrow
- The type of loan you apply for
- Your personal credit score
Some lenders may require you to pledge collateral that is equal to 100% of the value of the amount borrowed.
One of the main considerations when applying for a business loan is how much you want to borrow.
Loans with a higher value typically require collateral. If a loan exceeds a certain number, many lenders will need it to be backed up with personal or commercial real estate.
Loans that are smaller in value may not require specific collateral but nearly always come with a personal guarantee or a blanket lien requirement.
Just because a borrower has a low credit score does not mean they are immediately rejected for a loan. Some borrowers in this situation may qualify for a loan by securing it with collateral.
There are many different types of loans and each may require a different form of collateral. For instance, if you want to finance a specific building for your business, the building itself could be collateral.
You may also be required to use specific business assets or sign a personal guarantee if you want to qualify for an installment loan.
These loans must be paid back regularly with scheduled payments or in installments.
Collateral is different for every loan. This is why it is very important that you understand what collateral is required for the specific business loan you are applying for.
Thoroughly read the contract and discuss any queries with your lender. They will help you understand the details of the loan better than anyone.
Before you apply for a loan, you must make sure that you understand the lender’s policy on collateral first. Fully understanding this will be beneficial to both you and the lender.
Being able to supply collateral provides the lender with protection against any missed payments but it also opens up an easier path for you to get a loan.