Tips for Using Collateral to Secure a Business Loan

There are multiple reasons as to why someone might need cash for their business and seek out a loan from a bank. There are many kinds of loans out there and you need to do your research and find which loan is best for you and your business. Two types of loans you can consider are secured or unsecured business loans. A secured loan is backed by an asset which is called collateral, such as your car or your home. An unsecured loan does not use collateral and it is not necessary to qualify for financing.

There are many advantages for using collateral to secure a business loan:

  • High chances of qualifying
  • More loan options
  • Better payment terms
  • Low interest rates

Although unsecured loans do not require much paperwork or collateral, they do have more strict criteria.

If you plan to apply for a secured loan, here are a few tips on how you can improve your chances of getting approved.

Find Out What Can be Used as Collateral

Most lenders have similar definitions of what can be used as collateral, but it is important to understand what your options are so you can secure a loan.

  • Equipment – if you default on payments, the equipment becomes the lender’s property.
  • Automobiles – you can use your car as collateral if you own it or if the amount that is owed is less than its value.
  • Home equity – this type of collateral is the most valuable asset of an individual.
  • Commercial properties – if you are buying property, that property can be used as collateral.
  • 401k - although you can use a 401k as collateral, they have some limitations and tax limitations.
  • Accounts receivable and purchase orders – asset-based lenders will give your loan 100% of the value of your receivables. The benefit is that the lender decides to pursue the payment from the customer of the unpaid invoices and if the customer does not pay then you will be responsible of only paying the initial invoice amount and are not risking losing any assets.
  • Merchant cash advances – your business can also trade a portion of credit card sales for a lump sum loan. This type of financing is very flexible, but interest rates can be high.
  • Cash savings – personal savings that you have will also work as collateral because it is a low risk for the bank.

Know How Much Collateral is Needed

Two factors that determine how much collateral is needed for a loan depends on the details of the loan and the financial situation of the business. Collateral needs to be worth the amount that is equal to that of the loan, or it needs to be higher in value than the loan.

Some lenders do not require any collateral with unsecured financing. Unsecured loans are small but they have interest rates and long repayment terms. You need to assess what your company can afford.

Understand the Risks

There are risks involved when using your assets as collateral. Be sure to discuss the risks with your financial advisor and anyone that could be affected if you lose your asset due to defaulting on payments. Also, know how much your asset is worth and keep detailed records of the value of the asset. Lenders need to know that their investment in your business is covered by the value of the asset you use as collateral in case you default on repayments.

Negotiate as Much as Possible

Research alternative options before negotiating so you are happy with how your application is processed. Compare different offers from multiple lenders and consider which one works best for you.

Where to Find Collateral Loans

Consider the following types of lenders when doing your research for loans.

  • National banks: borrowing from a bank is a good option if you are already a customer or if there are not any other convenient options near you.
  • Community banks: small local banks are more likely to work with local customers if you do not have success with a national bank.
  • Credit unions: these financial institutions have low rates and attractive terms.
  • Online lenders: online banks could have opportunities for you that you cannot find with banks or credit unions.

Alternatives for Collateral Loans

If you do not feel comfortable using collateral, there are alternative options available.

  • Unsecured personal loans: you can obtain these without collateral. The only drawback is there might be strict qualifications and high interest rates associated with it.
  • Credit-builder loan: this will deposit money in a bank account for you and hold it until the term of the loan ends. Once it ends and you have paid it back, you get the cash. The drawback is that this does not offer immediate access to funds.
  • Family or friends: if you have a good relationship with family or friends, it might be useful to ask for help. It is up to you to decide if this is a good option for you as this also comes with its own set of challenges as well.