When it comes to getting a business loan, you usually have a choice between two options: secured and unsecured loans. Unsecured loans are loans that do not require collateral, and secured loans are backed by a valuable asset of some kind.
Loans secured by collateral are more likely to be approved, come with a lower interest rate, and often have better loan terms. However, there are both pros and cons to secured business loans, and it’s important that you understand them before you decide to apply for one. Here are three things you should know when using collateral for securing a business loan.
The Potential Issues with Collateral
Whatever the case may be, lenders will be concerned about your ability to repay a loan. Backing the loan with some sort of collateral ensures that the loan will be repaid, but the asset must be valuable. However, you need to be careful when choosing collateral and not put up something that will seriously hurt you or your business if it gets seized. Offering your car, for example, could leave you crippled if you end up defaulting on your loan.
While it is true that you can raise more capital with collateral than without, you also have to know which type of collateral they’ll accept. Some lenders will not even allow you to put up a vehicle in the first place. You should also note that assets you want to offer as collateral must also be available for repossession.
The Types of Collateral You Have Available to You
When someone talks about a secured business loan, their first thought is generally about the biggest physical assets they have like real estate and equipment. However, you can also take out loans secured by your financial assets like inventory and accounts receivable.
One benefit of this approach is that the loans are independent of your credit. For accounts receivable, for instance, the amount of money you receive is mainly based on the age of the invoices and the creditworthiness of your customers, not you.
Small businesses could also use their cash flow to secure a loan. In these cases, you’re giving a portion of the credit card sales or deposits to your bank account to pay toward your loan. Note that these loans aren’t dependent on your personal credit score either. However, you should know that they come with a relatively high-interest rate.
The Risks You May Be Taking
It’s essential that you understand the risks of a secured loan before getting one. While loans are secured by collateral, the collateral itself may not completely insulate you from the financial fallout. Many lenders require a personal guarantee in addition to the collateral, and in this case, you could be pursued for the difference between what your asset sells for and the balance on the loan.
This is why it is important that you protect yourself by keeping detailed records of the value of the asset. You should also have an independent auditor assess the value of the asset before you apply for the loan so that you know how much it is really worth.
Secured loans could be a great way to increase your chances of getting financing. If you have valuable assets and are thinking of using them as leverage, make sure that you assess the risks and potential rewards before you make your final decision.