When a business needs a short-term loan, one of the options to consider is using assets as collateral. Assets are valuable items that the business owns and can pledge as security to the lender. By doing so, the business reduces the risk for the lender and increases the chances of getting approved for the loan. However, not all assets are created equal, and some are more suitable for collateral than others. In this article, we will explore the two main types of assets typically used as collateral for a short-term business loan.
1. Real Estate
Real estate is one of the most common types of assets used as collateral for a short-term business loan. Real estate includes land and any structures or buildings on it, such as warehouses, offices, or retail spaces. Real estate is a valuable asset because it tends to appreciate over time, meaning its value increases. Additionally, real estate is typically a long-term investment, which means that it is less likely to be sold quickly, making it a reliable asset for lenders.
When using real estate as collateral, the lender will typically conduct a property appraisal to determine its value. The loan amount will typically be a percentage of the appraised value, called the loan-to-value (LTV) ratio. Lenders may require a minimum LTV ratio of 70% to 80% for real estate collateral. This means that if the property is appraised at $1 million, the borrower may be able to obtain a loan of up to $800,000, depending on the lender's specific requirements.
Real estate collateral can be particularly useful for businesses that need a significant amount of capital. For example, if a business needs to purchase new equipment or expand its operations, a short-term loan secured by real estate can provide the necessary funds. However, it's important to note that using real estate as collateral comes with risks. If the borrower is unable to repay the loan, the lender may foreclose on the property, meaning that the borrower could lose ownership of the asset.
2. Accounts Receivable
Another common type of asset used as collateral for a short-term business loan is accounts receivable (AR). AR refers to the money that a business is owed by its customers for products or services that have been delivered but not yet paid for. AR can be a valuable asset because it represents future income that the business is expected to receive. Additionally, AR is often a short-term asset, meaning that it is expected to be collected within a few months.
When using AR as collateral, the lender will typically conduct a credit analysis to determine the creditworthiness of the business's customers. The lender may require a minimum credit score for the customers, as well as a minimum percentage of the AR that is expected to be collected. For example, the lender may require that at least 80% of the AR is expected to be collected within 90 days.
AR collateral can be particularly useful for businesses that have a high volume of sales but may experience cash flow issues due to slow-paying customers. By pledging AR as collateral, the business can obtain a short-term loan to bridge the gap until the AR is collected. Additionally, AR collateral can be less risky than real estate collateral, as the business retains ownership of the asset. However, it's important to note that using AR as collateral comes with risks. If the borrower is unable to repay the loan, the lender may take possession of the AR, meaning that the business may lose future income.
The two main types of assets typically used as collateral for a short-term business loan are real estate and accounts receivable. Real estate can be a valuable asset because it tends to appreciate over time and is a long-term investment. Accounts receivable can be a valuable asset because it represents future income that the business is expected to receive. Both types of collateral come with risks, and it's important for businesses to carefully consider their options before pledging assets as collateral. By doing so, businesses can obtain the necessary funds to meet their short-term financial needs and grow their operations.