4 Types of Collateral That Could Be Used to Secure a Loan
That’s because there are several types of collateral that can be used to secure a loan. Of course, as with any financing-related choice you make, there are benefits and drawbacks related to the collateral you choose. So, in this post, we’ll review four types of collateral you could use to secure a loan in addition to how your choice of collateral will affect your business.
Consider These Types of Collateral When Pursuing a Secured Business Loan:
1. Real Estate
With home prices having risen over the past six years, using a home as collateral for a business loan is a viable option for many entrepreneurs. For lenders, real estate is an attractive way to secure a loan because it holds its value well. Entrepreneurs may also benefit because real estate is generally worth at least a couple hundred thousand dollars, which gives owners a chance to secure larger loans.
However, while real estate may be a convenient choice, it’s also a risky one. For example, if you put up your primary residence as collateral and default on your loan, you’ll lose your home. Of course, you could also use other real estate you own and use to run your business, but that’s a risky move as well, especially if you rely on that property for income.
Of course, risk is relative. If you own real estate that’s less critical to your life or business, it may be worth using as collateral.
Equipment can make for a good choice of collateral, but that depends on a few notable factors.
First, you’ll need to consider the value of the equipment, not just the price. For example, heavy machinery may technically be valuable, but if it’s difficult to find a buyer, it won’t be viewed as valuable to the lender. Similarly, computers or other hardware tend to become obsolete fairly quickly, so their value depreciates over time.
Still, if the loan amount is relatively low, equipment may be a great option to use as collateral. As the borrower, though, you should contemplate the consequences of losing that equipment to decide whether it’s worth the risk.
Another type of collateral that business lenders will accept is inventory. In fact, from a lender’s perspective, many of the considerations for equipment, such as liquidation value and future depreciation, apply to inventory as well. As a result, the amount and cost of your loan may change depending on how the lender values your inventory.
Again, by putting up inventory as collateral, you’ll risk losing your inventory if you default on your loan. As you can imagine, this can create a difficult scenario, especially if you have other debts. In the event of default, your inventory will be gone, and you may have no other ways to generate a profit and pay off other debts.
Waiting for payments on outstanding invoices often causes cash flow challenges for small business owners. However, you can put those invoices to work by using them as collateral for a business loan. If you choose to use invoices as collateral, you’ll receive cash from your lender and when it comes time, they’ll collect on the outstanding invoices.
As a business owner, you receive cash up front and don’t have to worry about waiting for the cash from your invoices to come in. However, you’ll have to pay fees or other costs to the lender which means your business will earn less money than it would if you collected the invoices yourself.
Finally, because the loan amount will be capped somewhere below the total value of your invoices, there will be a ceiling on how much you can borrow.
Conclusion: What’s Your Downside?
While deciding which type of collateral to use is by no means easy, it’s a fairly simple decision that boils down to one primary consideration; what are you willing to lose? Regardless of what you use as collateral, you need to live with the possibility that you could lose it, even if the chances of default are relatively low.
Once you answer that question, you can narrow your choices down based on what you need and the terms you’re likely to receive based on the type of collateral. For example, if you need a loan of over $100,000, most equipment won’t be worth enough to serve as collateral for a loan that large.
After understanding your needs, risk tolerance, and the limitations of different types of collateral, you’ll know which type of collateral best serves your business.
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.