Understanding Five Types of Business Loan Collateral
What to consider before signing off real estate or other precious possessions.
Putting up collateral for a loan is a practice almost as old as civilization itself, with records of secured loans in ancient Mesopotamia, Babylon, and the Roman Empire, which had many variations of collateral-based loans. In 2023, the tradition continues. The customs may be different, but there are still pluses and minuses.
Collateral: Part of a larger financial fitness profile
You may be considering a secured loan as a financing option. Such collateralized loans typically come with more attractive terms, including lower interest and longer payoff periods, than unsecured financing. Of course, pledging collateral alone doesn’t get you to the finish line. The amount you're requesting, the payback term, and your overall personal and business credit health all factor into a funding decision.
Though collateralized business loans come with built-in risk, defaults are infrequent. Federal Reserve Bank statistics show that only 1% of commercial-bank business loans defaulted in 2022. Still, this isn’t a 1% club you want to join.
Each of the following collateral types has its pro(s) and con(s).
Real Estate is an attractive asset to lenders, due to its inherently stable value. Borrowers may also be able to get relatively larger amounts of cash, with better terms, than other forms of collateral. But are you willing to face the potentially life-disrupting risks of putting your home or business location up for collateral? Best bet: Use an investment property, second home, or other location that’s potentially less disruptive to your life.
Equipment is less attractive than real estate to lenders, due to its fluctuating value. For example, heavy machinery may be expensive, but resale is a challenge. Similarly, computer equipment is relatively less expensive and devalues quickly. For these reasons, equipment-backed loans are decent alternatives for lower loan amounts ($100,000 or less).
Inventory, from a lender's perspective, is similar to equipment since its liquidation value and future depreciation varies widely. So, it may not avail you of advantageous enough terms to warrant losing raw materials and/or merchandise.
Securities such as stocks, bonds, or other assets may qualify as acceptable collateral. More typically, this form of collateral applies to larger loans or lines of credit.
Invoice financing lends you cash up front on pending accounts receivable. When the invoices are paid, the lender levies one or more fees and you take a revenue hit. Since lenders typically cap invoice financing loans at somewhat less than your total invoice value to minimize their risk, you’re restricted to a lower amount than you may need.
Consider your financing alternatives
There's no lack of non-collateralized financing options for businesses seeking working capital. Options include traditional secured and non-secured bank loans, SBA loans, and fintech lending solutions. Requirements vary. Depending on the type of loan and the lender, you may even qualify if you have a low personal or business credit score. That’s because some lenders base your creditworthiness on the average amount of your receivables, the year’s past income, and other more recent indicators of financial health.
It's smart to consider each of these options prior to submitting a loan application. Work with your accountant and lawyer, and other trusted professionals to decide what best suits your business needs.
Fora Financial collaborates with its partners and customers to develop innovative funding services for America's small businesses. Since our founding in 2008, we've distributed $3 billion to 35,000 businesses. Click here or call (877) 419-3568 for more information on how Fora Financial’s working capital solutions can help your business thrive.