Types of Collateral for Business Loans

If you’ve ever borrowed money from a bank, you might have come across the term “collateral.” It is a valuable asset which you pledge as security for your loan. For example, if you borrowed money from the bank to buy a house, the bank takes the house as a collateral for your loan. The same goes for a car loan. These assets serve as a guarantee to the bank that in the event that you don’t or can’t pay off your loan, they can just take back the collateral from your possession and sell them off. 

A collateral typically comes into play when you’re asking the bank for a large amount of money. Lending a huge sum comes with big risks, so to decrease or minimize their risk, banks often ask for a collateral as guarantee for the loan. On the other hand, having a collateral gives you access to loan amounts that you might not be offered otherwise. So, it’s a win-win situation in the end. 

For a business loan, banks will accept different assets as security. For example, asset-based loans.

Below, we will discuss some of the types of collateral for business loans. 

Real Estate

Real estate is a common collateral used not just in business loans but also in mortgages and personal loans. It comes in many forms and can be the borrower’s personal property or belong to the business. Your home, home office, or land can be collateral. Commercial properties, such as buildings, commercial lots, office spaces, or warehouses, can also be used to secure a business loan.

Among the collateral listed in this article, real estate is the most valuable. For one, real estate has a high value that appreciates or increases over time. As a result, lenders like having real estate as collateral for loans because it offers them a high level of security. 

On the borrower’s end, real estate allows you to get larger amounts of funding with a longer payment term. However, putting real estate as collateral of a loan comes with a significant risk. If you default on your payments, the bank will have the right to take ownership of the property and sell it to recover their losses. So, if you put your home as security for a loan and you can’t pay it back, you could end up losing your house. 

Business Equipment

Business equipment encompasses manufacturing machinery and office equipment, such as computers and printers. Basically, this includes all the tools, machinery, and vehicles like semi trucks used in the day-to-day operations of the business. 

If you’re planning to buy a new one, that piece of equipment will serve as your loan collateral. Because it isn’t as high value as real estate, business equipment is a relatively low-risk collateral. 

However, unlike real estate, an equipment’s value decreases or depreciates over time. As a result, lenders will be much more conservative with their valuations, which means a lower loan amount. This is especially the case if the equipment is old or heavily used, i.e., has more wear and tear. The same is true for unique equipment or those that lenders think will be hard to find an interested buyer. 

Lenders will need to see the receipt in order to assess the equipment’s value. 

• Inventory

If you need money to purchase inventory, you could apply for a business loan to do so. The loan proceeds will be used to buy the inventory, which will serve as the collateral. Inventory are products, goods, or materials that businesses—usually in the retail sector—hold for sale.

Not all lenders accept inventory as collateral, but those who do have to consider how easy or hard this inventory is to sell, what will be its liquidation value, and its future depreciation in order to assess its value. They may also require the borrower to provide regular updates on inventory levels and values as part of their loan agreement. 

Putting your inventory as collateral for a loan is quite a risky move. With lenders requiring inventory value to be the same as the borrowed amount, you could lose access to a part of your inventory that might have generated profit. In other words, you have inventory which doesn’t earn revenue. 

• Accounts Receivable

Accounts receivables are unpaid invoices owed by customers to your business. If your business has strong sales but slow payment cycles, you might be able to use your accounts receivables as a collateral for a loan.

It’s like getting a cash advance from the payments that will be due at a later date. You won’t receive the entire amount, but at least you have some money now to finance your operations. So, you get the money now and the factoring company will collect those payments from your customers when they become due. 

Before lending to you, however, an invoice factoring company will have to assess the quality and reliability of your accounts receivable. When the payments come in, they usually take their cut in the form of a fee, so you will not get the full value of your unpaid invoices. But, this is better than waiting months to get paid. 

Another advantage of using accounts receivables as collateral is your inventory won’t be held up by the lender. So, you can sell them without issues and earn profit. 

• Blanket Lien

A blanket lien is basically a guarantee that in the event that you default on your loan, the lender can take as many of your assets as it takes to pay off your loan. As you can expect, this is a risky collateral for borrowers.

• Cash Savings

Cash is the most liquid asset, so if you offer your cash savings as collateral, most lenders will have no problem with that. Unlike an asset used as a collateral, cash doesn’t require them to sell anything. 

Putting up your personal or business bank account as collateral allows you to secure a high loan amount at a low interest rate.

Investments

You can use stocks, bonds, and other investments as collateral for a business loan. Since they are easy to value and liquidate, lenders typically don’t say no to them. However, their value is affected by market conditions. So, there’s a risk that their value might decline below your borrowed amount.