There are many types of loans that businesses can apply for, but each type of loan will have its own criteria for eligibility. In general, lenders look for things like high credit scores, long years in business, and a steady cash flow before approving a business for a loan. These are preferred qualities to have, but if you’re a small business owner who needs to secure some much-needed funding and is lacking in some of the general requirements, collateral can help better your chances.
Protecting the Lender
Collateral is an asset or several assets that a lender uses to protect themselves during a loan agreement. It’s a method of minimizing the risk in letting you borrow money from them because the lender can seize the agreed-upon assets should you fail to pay your loan. Those assets are then liquidated, and the resulting cash is used to pay off the remaining balance on the loan. Having the borrower pledge a valuable asset also helps ensure that the borrower pays their loan promptly so that they do not lose their assets.
Collateral is an asset that can be liquified easily. Lenders like having the ability to turn assets into cash without any problems. In fact, cash itself would be the best asset to help you secure a loan, so if your business has high capital, you will have a higher chance of securing that loan. Other types of viable financial assets include stocks or bonds. When it comes to property-specific loans, such as real estate or equipment, the property purchased with the loan will be listed as the pledged asset. In some cases, personal assets such as a vehicle or a house could be pledged if the value of your business’s assets is not sufficient. Pledging personal assets is risky, though, so ensure that you have a plan implemented.
Determining the Value of Your Pledged Assets
Collateral should, at the very least, match the loan. This is easy in cases where you acquire an equipment loan to purchase a new piece of machinery because the value is known during the purchase. However, there may be times where an asset’s value cannot be easily determined, such as with personal assets. In these situations, appraisals will be necessary. You can lower the amount of collateral you’ll be requested to produce by having excellent credit, increasing your interest rate on the loan, and increasing your capital.