How Much Collateral is Needed to Receive a Secured Business Loan?
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 many factors. After all, there are four “other C’s” that the lender is evaluating, so that they fully understand the financial health of your business.
Still, there’s more than just your financial health that affects how much collateral you’ll need to submit. The type of financing you’re looking for and the kind of collateral you’re putting up also play a role in the final loan terms.
To help you sort through all the factors involved, we’ll outline how to determine the amount of collateral you’ll need to receive a business loan.
Evaluating “The Five C’s”
It’s important to remember that the amount of collateral you need to put up depends on the financial health of your business. The Five C’s break your financial health into the following five categories:
Credit History: Your reputation as a borrower.
Capacity: Your ability to repay a loan, based on your existing debt load and income.
Capital: The amount of money you’re putting towards the investment. For example, the down payment on a home.
Collateral: The asset that the lender may take possession of in the event of a default.
Conditions: Other terms of the loan like interest rate, term, amount, etc.
It’s important to note that the amount of collateral you need is affected by these four other 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, and you have a stellar credit history and plenty of cash to repay a loan, not having enough collateral might not be an issue. You’ll find that most lenders will operate based on this same principle.
The Types of Financing that Require Collateral
As you look for financing, you’ll likely come across both secured and unsecured loans. Keep in mind that any loan that is referred to as a “secured loan” will require collateral.
Typically, the following types of financing require 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.
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: Taking the Right Risks
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 you’re determining what type and how much collateral to put up, think of 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. By understanding the worst-case scenario for each risk you take, it’ll be easier to get comfortable with that decision.
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.