Cash Flow Solutions

How Much Collateral Is Needed for a Business Loan?

A small business owner chopping vegetables after expanding his operation with a small business loan

When comparing small business loans, it’s important to understand which options require business or personal assets to be used as collateral. 

With a collateralized loan, also called a secured loan, a borrower gives the lender the right to claim the assets they pledge. The collateral limits the lender’s risk because it can take the assets if the loan is defaulted on. 

As a result, it might be easier for a borrower to get approved for a business loan with collateral, and to qualify for more favorable terms or a larger loan limit. However, what can be used as collateral and how much collateral is needed could depend on the lender and the type of loan. 

How do lenders determine the amount of collateral required? 

Lenders may have different collateral requirements based on the type of loan, the type of asset being used as collateral, and the business’ finances. 

For example, vehicle and commercial real estate loans are secured loans that can be taken out to purchase a vehicle or commercial real estate — the asset purchased secures the loan. The borrower may also be required to include a down payment as an additional guarantee.   

With other secured loans, borrowers might use an existing asset as collateral — such as savings in a business bank account or equipment they own. The asset’s value could determine how much money the lender will offer. 

Lenders may look at various factors when determining if a business owner qualifies for a business loan. Some of the factors that go into their decisions regarding maximum loan amount, interest rate, repayment terms, and down payment or collateral requirements can include: 

  • Credit score: Having a good personal and  business credit score can help a borrower qualify for a lower-rate loan or a loan with less collateral. 
  • Debt-to-income ratio and capacity: Lenders want to be sure borrowers can afford a new loan payment for their business. They may consider a debt-to-income ratio (DTI), which compares a business’ monthly net income and debt payments. Other factors can also impact a business’ overall capacity to afford payments, such as  cash flow, or how much money comes into or goes out of the business each month. 
  • Repayment capacity: A  business plan and  financial statements — the balance sheet, income statement, and cash flow statement — can help the lender understand a business’ financial situation and prospects. The lender may want to know how much money has been invested in the business and how much has been taken out of it. 

One thing to remember is that collateral is a type of safety net. If the loan can’t be repaid, the lender can take and sell the collateral to help cover its losses. In many cases, the lender might want enough collateral to cover the entire loan. For example, a lender may use a piece of equipment that’s worth $50,000 to secure a $50,000 loan. 

Highly successful businesses with long histories of repaying loans on time might be able to receive a loan without collateral or with lower collateral requirements, as lenders might feel more comfortable providing these business owners with funds.  

Does every business loan need collateral? 

Only secured business loans require collateral. By contrast, unsecured business loans don’t require any collateral; the loan’s terms are based on the business’ finances and creditworthiness. If the business is new, has bad credit, or low profits, it might be difficult to qualify for an unsecured loan with favorable terms. 

Even if a business owner can get approved for an unsecured loan, they might decide to use their assets to secure the loan. In general, offering collateral can help a borrower qualify for a larger loan and more favorable terms. 

But there is a risk. If a borrower defaults on an unsecured loan, the lender may be able to sue the business for the unpaid amount — that can be a lengthy process. With a business loan with collateral, the lender can quickly take the agreed upon assets if payments are not made on time. 

What can be used as collateral for a business loan? 

Any business or personal asset can be offered as collateral, but the decision to accept the collateral is ultimately up to the lender. For example, family heirlooms might be valuable to an individual, but the lender may disagree and refuse to accept them as collateral. 

Lenders might also offer different loan amounts based on the type of collateral and how easy it will be to sell. For instance, a business may have $100,000 worth of inventory, but the lender will only accept it to secure a $50,000 loan — the loan-to-value ratio (LTV) is 50 percent. A lender might not give a loan for the full amount because it will have to sell the inventory at a discount during a liquidation sale. 

And if a business has specialized equipment or inventory, the business owner might consider looking into  industry-specific loans that are geared towards those assets. 

However, owning $100,000 worth of real estate might allow a business owner to secure a larger loan — perhaps $65,000 to $80,000. Lenders don’t necessarily need to be specialized to understand the value of the property, and they may be able to sell it quickly without taking a large loss. 

Types of collateral for business loans 

Lenders generally prefer collateral that maintains or increases value over time and is easy to sell. Common types of collateral for business loans include: 

  • Cash: Funds in a business checking account or savings account might be able to be used to secure a loan. However, the borrower will not have access to these funds while they’re repaying the loan. 
  • Real estate: Small business owners often use personal and commercial real estate as collateral for large and long-term loans. 
  • Vehicles: Business or personal vehicles can act as collateral for a loan. 
  • Business equipment: Expensive manufacturing, production, or office equipment can also be valuable as collateral. Like mortgages and auto loans, there are equipment loans that use the equipment purchased as collateral. 
  • Inventory: A vendor or supplier might offer a loan to purchase inventory or use a business’ existing inventory as collateral for a new loan. 
  • Outstanding invoices: Some lenders will offer loans based on  outstanding invoices. Similarly, factoring companies will purchase a business’ accounts receivable rather than lending against them. 

Is a personal guarantee the same as collateral? 

By signing a personal guarantee, an individual is promising to personally repay the loan if their business defaults. The guarantee isn’t a type of collateral because there is no specific asset being used to secure the loan. However, lenders may be able to sue the signer and garnish their wages, bank accounts, or take other personal assets to satisfy the debt. 

Many small business loans require every business owner (generally, anyone who owns at least 20 percent of the business) to sign a personal guarantee, sometimes in addition to pledging collateral. Partial owners who own less than 20 percent may be able to sign partial personal guarantees that limit their responsibility for the debt. 

What are UCC liens? 

Lenders may file a UCC lien, also called a UCC-1 financing statement or UCC-filing, which gives them the right to take the collateral listed in the filing. To get the loan, the filing may list the collateral that they’re putting up, such as the real estate, equipment, or inventory. This list can help notify other creditors that these assets have already been pledged to another lender. There are also blanket liens, which essentially give the lender the right to all a business’ assets. 

Business loans that require collateral 

Although there are some  business loans that don’t require collateral, many common types of loans might, depending on the lender and the amount being borrowed.  

SBA loans 

There are several Small Business Administration (SBA) loan programs. The popular 7(a) loan program may require collateral, a personal guarantee, and a blanket lien. The SBA requires lenders to try to fully collateralize loans over $350,000and allows borrowers to use business and personal assets to do so. 

However, SBA loans for $25,000 or less don’t necessarily require any collateral. Lenders can choose if they want to require collateral for loans under $350,000.  

Commercial real estate loans 

A real estate loan will almost always require collateral, as these are large and long-term loans. In general, the property purchased will be the collateral for the loan, which doesn’t put any additional assets at risk. 

Equipment loans 

Equipment loans also generally require collateral. The lender will use the loan to finance the equipment itself. Sometimes these loans come from third-party financing companies or lenders and sometimes the manufacturer may offer financing directly to the business owner.  

Business line of credit 

A  business line of credit is typically unsecured and won’t require any collateral. However, a secured line of credit might offer a higher credit limit or lower interest rate. Collateral may also be needed if a borrower does not have a good enough credit score to qualify for an unsecured line of credit. 

Online business loans 

Some online loans might require a blanket lien or a specific type of collateral. Others don’t require collateral as they focus on fast financing based on an individual’s creditworthiness. In either case, a personal guarantee may need to be signed. 

The bottom line: collateral for business loans 

Many small businesses need financing to purchase equipment, real estate, inventory, and for working capital. Although a small business owner might be able to get an unsecured business loan, using assets as collateral could help them qualify for a larger loan and lower interest rate. Putting up collateral may even be a necessity for certain types of loans or if a business owner has poor personal or business credit. 

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