Collateral for a Business Loan

Imagine that you have finally decided to quit your day job and take a leap into entrepreneurship. You've pooled your capital, decided on a business model, and created detailed plans to get things up and running. There's only one thing that stands between you and the inevitable takeover of the business world: financing. Since you don't have the capital needs to seek out investors, your first stop is the bank. Confidently, you tell your banker what you are hoping for, only to hear a puzzling question: what are you willing to use as collateral?

Secured Vs. Unsecured Loans

If your only experience with loans extends to things like buying a car or securing a mortgage, the idea of negotiating collateral might be quite foreign. With these sorts of loans, the bank has a good idea of what you're using the loan for, and that you are paying for something that can easily be seized if you default on your payments. Other forms of loans, like business startup loans, are a little less clear.

The way banks see it, you are more likely to repay your debts if you have something to lose. Secured loans are loans that are ensured by secured debt, or the promise that an asset can be claimed and sold if the loan isn't paid back in full and on time. Evaluating the property that can be used as collateral, or something the bank can repossess should you become unable to make payments properly, can be a major factor in the underwriting process.

Unsecured loans, on the other hand, are loans that are not backed by any collateral. Interest rates, repayment periods and rules and regulations are often less desirable for unsecured loans, largely due to the lack of assurance the bank receives. While ideal for someone without the means to pledge collateral while securing a loan, the steeper interest rates and higher payments make these loans riskier for both the borrower and the lender.

Types of Collateral

Many different things can be used as collateral for a loan, although the assets in question can play a part in an underwriter's considerations. Banks prefer to see property you own, such as stocks, bonds, vehicles, insurance policies, cash, and land. With several of these assets, however, there is the idea of valuation to consider, something that underwriters frequently use to determine the amount of collateral required. For example, should you use your investment portfolio as collateral, you may have to pledge an amount higher than the face value of the loan to account for market fluctuations.

If you are looking to secure financing for a new or existing business venture, there are many things to consider, including the type of loan and the best collateral. Underwriters are more likely to grant secured loans due to the heightened sense of obligation to the borrower. Clearly, secured loans are generally a better option but for those without requisite assets, an unsecured loan may be the only choice. Before you borrow, be sure you understand the terms and conditions of your new loan. After all, when it comes to financing, there's rarely nothing to lose.