WHEN OFFERING COLLATERAL FOR A LOAN
Collateral is an item that is pledged to guarantee repayment for a loan. Collateral items are generally of significant value – property and equipment are often used as collateral, for example, but the range varies significantly, depending on the lending institution and variables in the borrower’s situation.
Collateral only comes into play when a company needs to make a secured loan. Unlike unsecured loans, in which a borrower is able to get a loan solely on the strength of its credit reputation, secured loans require borrowing companies to put up at least a portion of their assets as additional assurance that the loan will be repaid. Many start-up businesses turn to collateral-based loans to get their start.
Types of Collateral
Many different types of collateral arrangements can be made by companies, whether they are experiencing a financial crunch or making plans for expansion. Common types of collateral include the following:
Purchase Monet Security Interest (PMSI)
Also known as a chattel mortgage, this option allows the borrower to secure a loan by borrowing against the value of the equipment being purchased.
Businesses that utilize real estate – usually a personal residence – as collateral are generally requesting long-term loans of significant size (the company has plenty of other collateral options for smaller loans). The size of the loan under this arrangement is predicated in large measure on the market and foreclosure value of the property, as well as the amount of insurance coverage that the company has taken out on it.
Under this form of collateral, a company secures a loan by convincing another person to sign a note that backs up the promises of the borrower. This endorser is then liable for the note. If the borrower fails to pay, the bank expects the endorser to pay. Sometimes the endorser may also be asked to pledge assets. A guarantor loan security is similar to the endorser arrangement, except that the guarantor is not required to post collateral.
Another option for borrowers is to put up a portion of their warehouse commodities as collateral. With collateral receipts, the receipt is usually delivered directly to the bank and shows that the merchandise has either been placed in a public warehouse or has been left on your premises under the control of one of your employees who is bonded. Such loans are generally made on staple or standard merchandise that can be readily marketed. This type of loan is for a percentage of the cost of the merchandise.
This method of borrowing, which is sometimes referred to as “floor planning”, is similar to the warehouse inventory. Under this plan, display merchandise such as furniture, automobiles, boats, large appliances, and electronic equipment can be used as collateral to secure loans.
This encompasses all the various assets (merchandise, property, equipment, etc.), owned by the borrowing business that could be liquidated to repay the loan.
Many banks lend money against accounts receivable; in effect, counting on your customers to pay your loan. The bank may take accounts receivable on a notification or non-notification plan.
Under the notification plan, the purchaser of the goods is informed by the bank that the account has been assigned and is asked to make payments directly to the bank. Under this collateral agreement, lenders sometimes advance up to 80 per cent of the value of the receivables once the goods are shipped.
Savings accounts and certificates of deposit
Stocks and bonds
Publicly held companies have the option of offering stocks and bonds within the company as security
Some lenders are willing to accept the cash value of a life insurance policy as collateral for a; loan.