What is Collateral and How Does It Apply to Business Loans?
When applying for a business loan, business owners face several challenges. Owners have to compare loan rates, gather the necessary documentation, and understand the risks and requirements for each individual loan. Another challenge could be finding a form of collateral.
Collateral is a familiar term for anyone who has previously researched about loans, but newcomers may be confused towards the meaning and importance of the term. To make it easy, we summarize what collateral is and why it matters below.
What is collateral?
Collaterals are assets used to secure a loan. Collateral shows that a business owner is willing to pay back a loan, giving confidence to the lender in case the borrower defaults for any reason. Lenders put a lien on collateralized assets. This means that if a borrower defaults, the lender has a right to seize the collateral and sell it off to pay the outstanding debt.
For business owners, using collateral also shows to lenders that they are not a high-risk borrower. This could lead to favorable interest rates and other financing options, such as higher loan amounts or a loan that they would not have been able to qualify for without a collateral.
Is collateral needed for business loans?
It depends on the type of loan, the amount of a loan, lender’s policies, and your financial status. For smaller loans, lines of credit, credit cards, and short-term loans, collateral is usually not required by the lender.
However, even without collateral, most business loans require a personal guarantee, marking them as responsible for paying the loan. If the loan is not paid, personal assets can be seized to pay off the remaining debt and legal action can be taken.
What can be collateral?
Collateral can often differ between loans and lenders, but will usually be something of value. Business assets that can be collateral include:
Personal assets that can be taken from a personal guarantee would include:
How much collateral is needed?
Again, this would depend on the loan amount and other factors. A loan amount exceeding a particularly high threshold would require real estate as collateral, and smaller loans may require a personal guarantee instead of a specific collateral. Equipment loans require the equipment itself to be collateral.
By pledging assets as collateral, even businesses with limited credit history can qualify for a loan through asset-based lending or accounts receivable financing. The requirements around collateral will be detailed by your lender.
Which business loans need collateral?
Most business loans will have their own collateral requirements. We discuss in more detail below:
Bank loans are a common choice for business owners, a well-known option with competitive rates and multiple intended purposes.
The collateral requirements will vary, but most banks will often need a personal guarantee at the minimum. Specific collateral, such as a business’s buildings, equipment or personal real estate, may be required for higher loan amounts.
SBA loans are loans partially guaranteed by the Small Business Administration. All SBA loans will require some form of collateral, but will vary depending on the type of SBA loan. SBA 7(a) loans require collateral for loans above $25,000 and for a loan exceeding $350,000, it will need to be fully collateralized by the borrower. For SBA 504 loans, the asset being financed by the loan will be the collateral.
Commercial Real Estate Loans
Commercial real estate loans are used to buy land or commercial real estate. These loans can also refinance existing real estate loans or to fund expansions to existing facilities. Similar to personal mortgages, commercial real estate loans require borrowers to pledge the real estate that is being purchased as the collateral.
Equipment loans are used to buy more equipment for a business. Like commercial real estate loans, the purchased equipment is generally pledged as collateral.
Inventory loans are used to buy inventory for a business to sell its customer. The purchased inventory is pledged as collateral.
Accounts Receivable Financing
Accounts receivable financing can be structured as a loan or a line of credit, both of which are collateralized with your accounts receivable.
Accel Business Funding has many different funding options for all businesses and funded many businesses more than $380million. When banks say NO, we say YES to funding in 24hrs!
If interested in business funding, please contact:
Chris Han, Accel Business Funding
Tel – 818-963-8882