Modern business is difficult to predict. Every industry struggles to react to rapidly changing market conditions. There might occur times when businesses need a short-term cash influx to cover their temporary cash flow problems. Such monetary injections are also taken into account to capitalize on opportunities for expansion.
In times like these, collateral loans are preferred to many other lending options. As you acknowledge, “what is a collateral loan or what is collateral?” you will encounter how useful it is for business expansion and covering a temporary cash shortage.
Definition
Collateral is an asset of the borrower, which is used by the lender as a security for lending. It tends to offer lower rates and ensures reduced risk for the lender. As a result, if the borrower ends up defaulting, the lender will recoup losses from the collateral.
Traditionally, some financial institutions require at least one asset as collateral, be it a property, shares in a business, future profits, or unpaid invoices. Now, how much of that will be needed depends upon a wide array of factors, including the loan amount, term & purpose of the advance, and the business’s credit history.
Does It Make Sense?
If your business is viable over the long term, applying for a collateral loan seems to be making sense. However, if it is done against assets in order to delay the inevitable, it might not be the best solution for your enterprise. Still, if you have faith in your assets and believe they are robust with a demonstrably bright future, this could be the right choice. Not to mention, with collateral, it is easy to get a higher loan amount at lower interest rates and longer repayment terms.
Types of Collateral
If the asset you are keeping as a security with the lender is valuable, he/she will consider it. Some of the common forms of securities are:
Real Estate
One of the most common assets that people often use as security for obtaining monetary advance is their home or other similar property. Or in some other cases, money is also lent against equity held in a property.
Cash
Business bank accounts have been used as collateral for ages. Once the financial institution finds the borrower a defaulter, it will liquidate that account to stick to the payment plan.
Equipment
Usually, the business-owned equipment with significant resale demand and value is accepted as security. But many times, even when equipment like heavy factory-based machinery that is highly valuable is not suitable for getting a loan because the number of buyers for such machinery is limited.
Inventory Items
If your inventory is of reasonably high value, then you can keep your business inventory stock as collateral with the lender.
Invoices
Unpaid invoices mean you are expecting a cash flow in the future. This future income can be used to secure a loan. And if you fail to repay the loan, the lending institution can collect the money via those invoices.
Blanket Liens
This is a risky step that should be avoided if not necessary. In this, if you default in repaying the loan amount, the financial institution will use all the viable assets owned by your business as collateral.
A Personal Guarantee
It gives the lending institution the right to seize the personal assets of the borrowers now or in the future to satiate the outstanding business debt.
Facts
Even when you don’t own collateral, you can apply for unsecured financing. But that would be offered at potentially less favorable rates and repayment terms because the risk to the lender is greater this time.
You can avoid adding collateral, but that is not always easy. Though, instead of that, you will be asked to show sound goodwill, a long history of sound financial management, strong credit rating, bank statement, account records, and a comprehensive business plan.
Regardless, collateral loans are cheap and easy to apply, so they are the right way to go.