How to make a collateral loan work for your business

At some point in your business journey, you may find yourself with an opportunity to expand, but needing capital to do so. Perhaps you have the chance to buy a complementary business, to open another location, to hire additional staff, or to expand your product line. To take your business to the next level, you may need to take out a loan. To get the best loan terms, consider a collateral-based loan.

What is collateral?

Collateral is property or assets you pledge when you take out a loan. If you default on the loan, the lender can take the collateral and sell it in order to pay back the loan. It’s a way to make the loan less risky for the lender, because if the borrower cannot pay back the loan according to the agreed-upon terms, the lender isn't left holding the bag. 

It’s very common to have collateral for a loan. When you take out a mortgage, the home is collateral for the mortgage. If you default on your mortgage, the bank can foreclose on your home, and sell it to pay off the mortgage. When you get a loan to buy a car, the car is the collateral.

Sometimes you’ll hear a collateral-backed loan referred to as a ‘secured loan.’ This just means that the borrower has pledged some kind of collateral in order to get the loan. If no collateral is pledged, and the loan is granted based on the borrower’s creditworthiness and a promise to pay, it may be referred to as an unsecured loan. 

Related: 2 Options for small business financing: credit card or loan?

What can I use as collateral for a business loan?

Just about anything of value can be used as collateral, but the lender will determine what they will accept. If you’re using the loan to buy business property or equipment, the property or equipment you’re buying may be used as collateral for the loan, in the same way that your car is collateral for your car loan.

You can use your business property, like equipment, inventory, vehicles and the building you operate in, if you own it, as collateral for a business loan. You can also use your accounts receivable as collateral. In some industries, standard payment terms can be 60 days or more. It’s not unusual for companies to have outstanding invoices for thousands of dollars or more. These invoices can be used as loan collateral.

Remember that your collateral can be seized by the lender if you are unable to pay the debt. For this reason, it’s risky to use personal property, like your home, as collateral for a business loan. If your business goes south, you could also lose your home.

Can I get a loan without collateral?

You may be able to, but it’s riskier for the lender. This risk translates into higher interest rates for you, the borrower. If you have collateral and are confident in your ability to repay the loan, you may want to take a collateral-based loan over one that’s not, so you can get a better interest rate.

In some cases, a bank will take a personal guarantee in lieu of collateral. This means that you will pay the loan from your personal assets in the event that your business cannot pay the loan or goes bankrupt. A personal guarantee requires that you have personal assets, such as savings or investments, real estate, etc., equal to or greater than the amount of the loan, and that you agree to pay the loan with those assets if necessary.

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How much collateral do I need for a business loan?

There are a lot of factors that go into determining the amount of collateral you will need for a business loan. Your credit score, other debt you have, the nature of your business – these are all things a lender will consider when evaluating your loan application.

You may be required to put up collateral equal to 100% of the amount of the loan, especially if your business is new or the loan amount is high relative to your revenue. This is not unusual for a secured loan, because the lender wants to be sure they can cover the amount of the loan from day one. 

Getting a business loan can give you the funds you need to grow your business, but it’s not without risk. Protect your business against the risks you can’t see coming with business insurance from Hiscox. Get a quote and purchase online in minutes.