Do you need a loan? If you said yes, you’re like a lot of small business owners. Starting or expanding a business takes capital. It takes even more capital to take advantage of promising opportunities. You may want to stock up on inventory before a seasonal rush or buy the equipment of a competitor going out of business, for example.
Before you can secure a loan, you may be asked to provide the lender with assets it can sell in case you can’t pay back the loan. These assets are referred to as collateral. The lender looks at collateral as a cushion of protection against a default. In other words, if you don’t pay back the loan, the collateral is used to pay back the loan. This is why loans backed by collateral are also referred to as secured loans.
Lower risk translates into a higher loan amount. And, the more collateral you provide, the more the lender reduces their risk. In this way, you can use collateral as a way to negotiate the terms of your loan. Unsecured loans generally have higher payments due to shorter repayment periods and higher rates. The more collateral you pledge, the more leverage you have to reduce your interest rate or extend your repayment period.
The amount of collateral you pledge depends on many factors, the most important of which is the loan amount. Other factors include the term of the loan, interest rate, and repayment frequency. Likewise, the type of asset you can use as collateral depends on the lender, and doesn’t have to impact operations. Common types of collateral for small businesses include accounts receivable, inventory, equipment, land, buildings or other property. The more liquid the asset is, the greater the value it has as collateral. Liquidity refers to the amount of time it takes for an asset to be sold.