How Much Collateral Is Needed to Get a Secured Loan?
In any case, collateral will always be part of that evaluation. That’s because collateral provides protection for the lender if you’re unable to make your monthly payments. It also gives you the ability to receive financing that you otherwise wouldn’t be able to qualify for due to poor credit, short time in business, or other reasons. In other words, collateral is what your lender is left with if your business goes under.
However, the extent to which collateral plays a role in the approval of your loan application varies quite a bit based on numerous factors. After all, there are four “other C’s” that the lender will evaluate so that they fully understand the financial health of your business.
Still, there’s more than just your financial health that affects the amount of collateral you’ll need to submit. The financing product you’re applying for and the kind of collateral you’re putting up also play a role in the final loan terms.
In this post, we’ll outline how to determine the amount of collateral you’ll need to receive a business loan.
How to Determine the Amount of Collateral You Need in Order to Receive a Loan:
What Are “The Five C’s?”
It’s important to remember that the amount of collateral you’ll have to submit depends on the financial health of your business. The Five C’s break down your financial health into the following five categories:
Credit History: By viewing your credit report and determining your credit scores, the lender can review your reputation as a borrower. If you have a very low score, you may have to submit more collateral than you would if you had a good score.
Capacity: This “C” evaluates your ability to repay a loan, based on your existing debt load (such as outstanding credit card debt or existing loans) and the income your business generates each month.
Capital: This is the amount of money you’re putting towards the investment. For example, capital could be the down payment on a home.
Collateral: The asset as collateral that the lender may take possession of in the event of a default.
Conditions: Other terms of the loan like interest rate, term, and loan amount.
It’s important to note that the amount of collateral you need is affected by all these categories. For example, when the U.S. Small Business Administration evaluates if they’d like to insure a loan, they use similar criteria as the lender making the loan. According to the SBA loan fact sheet, “If adequate collateral simply is not available, this fact alone will not cause SBA to decline an otherwise qualified loan.”
In other words, if you’ve made a large down payment, have a stellar credit history, and have plenty of cash to repay a loan, not having enough collateral might not be an issue. Typically, you’ll find that most lenders will operate based on this same principle.
What Types of Financing Require Collateral?
As you look for financing, you’ll likely come across both secured loans and unsecured loans. Keep in mind that any loan that is referred to as a “secured loan” will require collateral.
The following types of financing might collateral:
- Commercial real estate loans
- SBA loans
- Equipment loans
- Small business loans
- Secured lines of credit
- Inventory financing
While these types of financing typically require collateral, many of them are also available without collateral. Usually, loans that don’t require collateral will have less favorable terms such as lower limits, shorter lengths, higher interest rates, or larger fees.
Of course, if you only need a small sum of cash, you could avoid the collateral requirement without having to pay a higher rate because the lender doesn’t need as much risk protection.
What Are the Different Types of Collateral?
Many lenders will allow you to choose what type of collateral you’d like to use. However, if you’re using an equipment loan, inventory financing, or commercial real estate loan, you’ll likely need to use either the equipment, inventory, or real estate you’re purchasing as collateral.
For other types of loans, though, such as small business loans, your business’s assets will serve as collateral. This could be assets such as equipment, real estate, inventory, accounts receivable, or cash.
Conclusion: Take the Right Risks When Pursuing a Collateral Business Loan
There’s no way around it. Putting up collateral for a loan is a risk. Then again, so was starting your own business.
However, as you know, taking the right risks at the right time is what can make or break your business. Therefore, when determining the amount and type of collateral put up, approach it like any other business decision.
For example, if you’re putting up equipment or real estate as collateral, consider what it’d mean to your business if you lost those assets. Also, think about what it’d mean to your business to not get approved for the loan, or what would happen if you had to settle for a smaller loan amount. By understanding the worst-case scenario for each risk you take, it’ll be easier to get comfortable with that decision.
Editor’s Note: This post was updated for accuracy and comprehensiveness in September 2019.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.