What Is Collateral For Small Business Loans?

As part of the application process, you may be required to provide collateral for a business loan. But what is collateral, and why does your lender require it?

In this post, we’ll break down what qualifies as collateral, why some loans require it, and how collateralizing your business loan benefits you.

What Is Collateral For A Business Loan?

Collateral is an asset used to secure a loan and ensure that the lender gets paid. The asset used as collateral is something of value that shows a lender that you’re prepared to pay off your loan. In the event that you are unable to make your loan payments, the lender can seize your collateral and sell it to cover the remainder of your loan.

Securing a loan with collateral decreases the risk a lender takes on. As a result, the lender is more likely to loan money to a small business.

Why Do Lenders Require Collateral?

Collateral allows a lender to protect itself by alleviating some of the risks that come with lending to individuals and businesses.

The lender places a lien on the asset (or assets) that is pledged as collateral for the loan. If you default, the lender has the right to seize the property and sell it to pay your remaining debt. Collateral ensures that if a borrower stops paying, the lender will still get paid.

However, collateral is not just in place to protect the lender. When a business owner pledges collateral, they can prove to the lender that they aren’t a high-risk borrower.

Collateral can lead to reduced interest rates and higher borrowing limits. Collateral can also help you get approved for loans you wouldn’t be qualified to receive otherwise. Reduced interest rates lead to a more affordable loan, and alternative financing options can also be less expensive in the long run.

Can I Get A Business Loan Without Collateral?

There are certain loans that may not require specific assets to be used as collateral. However, these loans may require a blanket lien or personal guarantee.

Collateral requirements, blanket liens, and personal guarantees will be established in your loan contract. Before signing, make sure you understand the collateral policies put in place by your lender.

What Can Be Used As Collateral For A Business Loan?

Each lender will have their own policies about what type of collateral can be used to secure a loan. In general, any business asset that has value and can be sold by the lender to pay off the loan if necessary can be considered collateral.

Common types of collateral for small business loans include:

• Real estate
• Buildings
• Equipment
• Vehicles
• Inventory
• Accounts receivables
• Future sales
• Cash reserves

The lender might also require a personal guarantee in addition to collateral. If you sign a personal guarantee, personal assets such as vehicles, real estate, or personal cash could be seized to pay back the loan in the event of a default.

How Much Collateral Do I Need For A Loan?

The collateral required for a small business loan is based on a number of factors, including:

• Loan Amount: Higher loans almost always require higher-value collateral like commercial or personal real estate.
• Type Of Loan: The collateral required varies by loan type. An example of this is that the collateral for equipment financing is the equipment itself.
• Credit Score: Business owners with low credit scores or no credit history may be required to provide collateral in order to secure a loan.

It’s also worth knowing that lenders often require collateral worth more than the loan amount — sometimes 1.25 to 1.5 times the value of the loan. This gives the lender a cushion in case the collateral loses value or is difficult to sell.

Be sure to thoroughly read your loan contract to learn the specifics of the collateral required and discuss any concerns you have with your lender.

Types Of Business Loans That Commonly Require Collateral

Whether the collateral is property or a personal guarantee, most business loans require some form of collateral. Here’s what to expect based on each type of loan.

One thing to be aware of is cross-collateralization,  a practice where a lender uses the same asset to secure more than one loan. This means that if you default on one loan, you could lose collateral that was tied to a completely separate loan. Always read your loan contract carefully to check for cross-collateralization clauses.

The Bottom Line On Collateral For Small Business Loans

Before applying for a loan, make sure that you fully understand the need for collateral. Not only does this provide the lender with the protection it needs to confidently loan money to businesses, but it also can help pave the way for you to get a loan.

Make sure that you fully understand what you are putting up as security and analyze your personal financial situation to ensure you’re not stuck with a bad deal further down the road. Shop around for better loan options if you need to. With proper planning, a little knowledge, and responsible borrowing, pledging collateral to obtain a business loan will only help you get the money you need when you need it.