What is Collateral? (Business Loan Context)
Understanding collateral requirements for business loans, what assets qualify, and how collateral affects your loan terms and approval.
Collateral is an asset you pledge to secure a loan. If you default on the loan, the lender can seize and sell the collateral to recover their money. Having collateral typically results in better loan terms because it reduces the lender risk.
Why Collateral Matters
Collateral serves as the lender safety net. If your business fails, the lender is not left empty-handed. This security allows lenders to offer lower interest rates, higher loan amounts, and longer terms than they would for unsecured loans.
For small businesses without long track records, collateral can be the difference between approval and denial.
Types of Business Collateral
Common assets used as collateral include:
- Real estate: Commercial property, land, sometimes owner personal residence
- Equipment: Machinery, vehicles, technology
- Inventory: Products held for sale
- Accounts receivable: Money owed to you by customers
- Securities: Stocks, bonds, or other investments
- Cash accounts: Savings or CDs pledged to the lender
Collateral Valuation
Lenders do not credit collateral at full market value. They apply discounts based on how easily the asset can be sold:
| Asset Type | Typical Advance Rate |
|---|---|
| Real Estate | 70%-80% of appraised value |
| Equipment | 50%-75% of value |
| Accounts Receivable | 70%-85% of eligible receivables |
| Inventory | 30%-60% of value |
Example
You own equipment worth $100,000 and want to use it as collateral. The lender applies a 60% advance rate, crediting you with $60,000 in collateral coverage. To fully secure a $100,000 loan, you would need additional collateral or accept a smaller loan.
SBA Collateral Policy
The SBA does not decline loans solely for lack of collateral if all other criteria are met. However, lenders must take available collateral. For loans over $500,000, real estate collateral is typically required if available.
Unsecured vs. Secured Loans
Unsecured loans require no collateral but typically have higher rates, lower maximums, and stricter credit requirements. They are available mainly to established businesses with strong financials.
Most small business loans are secured loans. Even if the specific loan does not require collateral, lenders often take a blanket lien on business assets as a precaution.
Cross-Collateralization
Some lenders cross-collateralize, meaning they use the same collateral to secure multiple loans. Read your loan documents carefully. If your equipment secures both an equipment loan and a line of credit, you cannot sell it until both are paid off.
Pledging your personal residence as collateral puts your home at risk. Consider this carefully and explore alternatives before using your home to secure business debt.
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Not Financial Advice: The information provided in this article is for general informational purposes only and does not constitute financial, legal, or professional advice. You should consult with qualified professionals before making any financial decisions.
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