Small businesses often start out with poor credit scores, which affects their ability to take out a business loan. However, you can boost your chances of getting approved for a loan through a collateral loan. But, what is a collateral loan?
A collateral loan is a secured business loan where you pledge assets as repayment to improve your creditworthiness. This will serve as the lender’s safety net if you, as a borrower, default on your loan and cannot pay.
5 Types of Collateral for a Business Loan
If you need business funding to finance your day-to-day operations, expansion, or a piece of equipment, below are five types of collateral you can use to secure a business loan.
1. Real Estate
A real estate or home equity collateral is any property you own, including your family home, lots, buildings, or commercial lands. This collateral is common since home equity is easily accessible to most business owners. It’s also ideal for lenders as it has a high value with low depreciation risks.
If you default on payments, lenders reserve the right to take ownership of your real estate and sell them to recover the losses quickly. Therefore, you’ll need to assess your real estate properties and choose one that holds the least value in your life but can back up the amount you’re trying to loan.
2. Business Equipment
If you’re planning to purchase business equipment using a loan, that piece of equipment can serve as your collateral. This is relatively low-risk, especially for construction or manufacturing companies. You can also put up your printers, computers, or copiers to back up payments if you default.
Although this is less risky than putting up your family home as collateral, you may only lend a small amount as lenders will take more depreciation risk. They’ll likely ask for your equipment’s receipt to assess the value, so check the depreciation of the equipment you’re putting up as collateral.
This collateral may only work if you’re a product-based company like retail or e-commerce shops. You can use the items in your inventory as backup payments if you fail to hold your end of the bargain. However, you’ll need to ensure that your inventory can back up your lending amount.
Lenders may ask a third-party auditor to assess the value of your inventory, especially if it is hard to sell. Other considerations also need to be taken, like liquidation value and future depreciation.
This is risky collateral on your end as it may directly affect your revenue stream and not earn from those inventory losses. The drop in sales may negatively impact your other debts and expenses, so evaluate all your financing options before taking out an inventory loan.
Unpaid invoices can affect your cash flow, which may cause issues in paying for your expenses and the like. You can put the invoices up as collateral to get cash upfront without waiting for a long period. It’s a good option for borrowers with a low credit score since viability will be based on the worth of outstanding invoices.
You can sell your unpaid invoices to a factoring company and receive around 80% to 95% of your invoice value. However, you’ll need to pay a fee of 0.50%–5% of your invoice value, so you may earn less than you would have if you collected the invoices yourself.
With that said, invoice financing is a better option than inventory loans since it gives you a flexible and secure payment scheme while ensuring you have other revenue sources.
Traditional lenders, such as banks favor this collateral as it’s the most liquid asset a person can have. On top of this, they won’t have to go through the trouble of selling a physical asset just to recover their losses.
The collateral for a business loan comes from extra cash from your bank accounts, whether a business or personal account, to back up your payments when you default. With this, you can take advantage of low interest rates and high loan amounts, corresponding to the money you have in your bank.
Collateral Business Loans FAQs
- How much collateral is needed for a business loan?
As a rule of thumb, any assets you’ll pledge as collateral should at least have the same or even surpass the worth of the loan you want to borrow. However, auditors will still have to assess their value. They’ll most likely appraise the collateral’s value by 80%–90% of the loan amount to consider other risk factors. So, as long as your collateral does not go below the loaning amount, you can get a business loan.
- How do I get a business loan without collateral?
You may need to get an unsecured business loan instead, which you can typically get from online lenders, banks, or credit unions.
Keep in mind that traditional lenders like banks require good business and personal credit scores, so you may have trouble getting an unsecured loan if you have poor credit. In this case, you can seek financial assistance from an online lender like JK Capital which offers non-collateral business loans with fast approval and minimal requirements.
- Does collateral improve my approval odds?
While pledging assets can approve your odds, you’ll need to match the value of your collateral to your loan amount to improve the terms of your loan. You’ll also need to consider the 5 Cs of credit—capacity, capital, collateral, condition, and character—to determine your odds of approval.
Finance Your Business Wisely
It may be difficult to get loan approval with a low credit score, but it’s not entirely impossible—you can pledge collateral to improve your chances. However, you’ll need to carefully deliberate when choosing an asset to pledge as you’ll need to consider your risk factors and the value it will hold to the lenders.
If you’re not willing to use collateral, you can always look for lending companies that offer unsecured loans like JK Capital. Check out our no-collateral business loans to find out more.