Lenders use different types of collateral to secure business loans. In this post, I will review the four common types of collateral used to secure loans. I will also explore how your choice of collateral can impact your business.
Business loans can be a great way to get some additional funds for your business when you feel the need for improvement, but do not want to dip into your own savings or the company cash for it. It can also be an option when you consider business expansion and want to bring some change in operations or technology.
For example, many business owners may find it useful in keeping with the times and migrating operations to digital environments such as the cloud (read more about how this could help you). To do this successfully, time, effort, and of course, money becomes necessary. So, when opting for a business loan, you should do so with prudence and with prior understanding of all that comes along with it.
Let us dive in to the different types of business collateral in this post today.
You can use your home as collateral to secure a business loan. Many lenders consider real estate ideal collateral because it doesn’t lose value over time. Real estate properties have high values and can help you secure large loan amounts. Whenever I want to apply for a large advance, I often place my real estate as collateral.
However, as ideal as real estate is, you should remember that it’s risky to place your home as collateral. If you put your home as a loan guarantee and default the loan, you might lose it. Other than your primary residence, you can also use other real estate property. However, it’s still risky, especially if you rely on the properties as an income source.
I often like using real estate as collateral because it motivates me to repay my loan efficiently. I wouldn’t risk losing my property, and this prompts me to make timely loan payments. Risk is relative; you only need to determine how much of a gamble you are willing to take when choosing which collateral you use.
Most business lenders accept inventory as collateral for business loans. Some of the factors that lenders will consider while using stock as collateral include future depreciation and liquidation value. The amount of the loan you qualify for and the applicable interest rates will vary depending on how the lender values your inventory. If you put up your stock as collateral and default on the loan payments, you will lose the items. This would be a challenge because, with your inventory gone, you will have nothing to sell. I would advise you to place your inventory as a loan guarantee only if you are sure that you can repay the amount without default.
I have used equipment as collateral for a business loan. However, before a lender accepts equipment for this, they will consider both its value and price. The lender will also consider the marketability of the equipment. Even if heavy machinery is valuable, lenders may not accept it as collateral because of its low marketability.
A lender might not accept equipment that depreciates fast because it will lose value over a short period. For instance, I don’t expect a lender to take a computer or computer hardware as collateral for a business loan. However, if you’re obtaining a relatively small loan, the lender might accept equipment as collateral. Before I place any equipment as collateral, I contemplate the consequences of losing the equipment.
Waiting for monthly payments on my outstanding invoices poses a cash flow problem for my business. I overcome this challenge by using the pending invoices as collateral for business loans. When you use an invoice as collateral, the lender will give you cash. They will recover the money from the invoices, commonly known as invoice financing. This way, you will receive some cash whenever you need it and won’t have to wait until your clients pay. However, your business will earn less money because you will have to pay the lender’s costs and fees.
There are several acceptable methods of collateral for business loans. Before placing an item, I always ask myself one question: what am I willing to lose? Whenever you place an item as collateral, you have to live with the possibility of losing it. After understanding this, you will have an easy time deciding about what to use.