Types of Collateral for Different Loans
Collateral is a security in the form of an asset or property offered against a loan. Financial institutions require collateral for mortgages and other secured loans, including foreclosure, non-recourse loans, and repossession. If the borrower stops making payments, the financial institution can take possession of the home or vehicle pledged.
The collateral can be equal to, less, or greater than the value of the loan. This depends on many factors, including credit score, income, and how liquid the asset is. Applicants can pledge anything of value, including real estate, vehicles, inventory, stocks and bonds, and equipment. Intangible and tangible properties are accepted by financial institutions. Tangible properties include machinery and equipment, fixtures, annuities, art, jewelry, etc. Intangible properties include investment funding, chattel paper, and payment rights.
Types of Collateral Depending on the Loan
The collateral required depends on the loan type and amount. Financial institutions that offer non-recourse loans accept stocks, real estate, jewelry, and vehicles. Companies that apply for commercial loans can offer marketing securities, natural reserves, real estates, and other assets. Some businesses use personal assets such as land and residential properties to secure financing. Companies that apply for a large loan may offer estate such as warehouses, office buildings, hotels, and shopping centers. Natural resources such as coal, gas, and oil are also used for long-term loans and before launching large-scale projects. Corporations, large companies, and syndicates often use machinery and factory equipment when applying for large loans. Certificates of deposit, treasury certificates, bonds, and stocks are used as collateral because they can be easily converted to cash. The amount of the loan offered depends on the value of the security.
Whether a limited partnership, public liability company, or sole proprietorship, most businesses apply for a commercial loan. Offering collateral is one way to prove to financial institutions that the company is a viable borrower. Before deciding on the type of loan to offer, financial establishments look at equity contributions, assets, revenues, credit history, and the company’s balance sheets. Most banks require collateral even if the company has a good credit rating.
Banks and Collateral
Financial institutions take a conservative approach when valuing assets to be pledged as collateral. The reason is that they will have to expend resources in case of default. Banks consider the fair market value of the asset and not what the company paid for it. It is a good idea to use the services of an independent appraiser. This is important if there is a substantial difference between the bank’s appraisal and what the asset is worth in the view of the company’s management.
Companies and individual borrowers can use two types of collateral – assets they’ve already pledged and assets and property they own. Financial institutions prefer property for which the borrower has a title of ownership. They accept different pieces of equipment and real estate, including second homes, motorcycles, trucks, and watercraft. Most banks won’t accept vacant land.
Borrowers who apply for a car loan can pledge the vehicle, their home, bond or stock certificates, etc. In addition to these types, applicants can pledge collectibles and valuables, insurance policies, cash and savings accounts, and future payments. Some assets are more heavily discounted than others. For instance, financial institutions may recognize 50 or 75 percent of the borrower’s investment portfolio. The reason is that banks risk losing money in case the investments drop in value.
There are benefits to pledging an asset to secure financing. First, secured loans come with a lower interest rate and a longer repayment period than unsecured debt. Banks face less risk in case of default and can repossess the property or asset pledged as collateral. With unsecured debt, financial institutions offer loans based on the applicant’s creditworthiness. Second, borrowers can use the money in many different ways - to pay bills, go on vacation, buy a house or vehicle, pay their tuition and board, or repay an expensive loan. Third, secured loans are easier to qualify for and even borrowers with a poor or imperfect credit score may be eligible. In fact, this is a good way to rebuild credit by making timely payments. Finally, the borrower can repay the loan at any time and save on interest payments.
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