Obtaining the necessary funding may always pose a challenge for most entrepreneurs, especially if low interest rates as well as a lengthy repayment term remain some of the non-negotiable terms. The best way to get a business loan is by looking beyond the importance of having a good credit report; it’s essential that you familiarize yourself with the art of maximizing your existing collateral, too. This includes equipment, properties, inventory, as well as your accounts receivable, which play a crucial role in enabling you to secure improved loan terms.
What Is Collateral, and Why Is It Important?
Collateral is defined as assets pledged by the borrower to secure financing and repay the loan according to terms and conditions established by the lender. If the borrower defaults, the lender can seize the collateral to recover any financial losses incurred. To the lender, collateral mitigates the potential risk of loss. To the borrower, the best way to get a business loan is to provide collateral, a greater chance of obtaining a lower interest rate, securing a loan, or having a longer term to repay the loan. Most traditional banks and SBA loan lenders require borrowers to pledge collateral when borrowing money. Additionally, providing collateral can be beneficial for those new businesses with a limited credit history that are seeking financing (i.e., business loans for startups).
Types of Assets You Can Use as Collateral
- Equipment: Any kind of business equipment that is physical and has a market value that can be verified, such as machinery, vehicles, or construction tools, can be promised. Particularly, equipment financing is very popular, as the purchased equipment itself is often the collateral.
- Real Estate: Either commercial or residential properties that are owned by the business or the business owner may be allowed for use as collateral. Real estate usually has a higher value, which makes it perfect for larger loan amounts and better rates.
- Accounts Receivable: Through invoice financing or factoring arrangements, the business can use accounts receivable to secure funding. The method is absolutely efficient for the business cash flow situation when there are slow payment cycles.
- Inventory: Businesses that have a great amount of easily valued stock, like retail or wholesale companies, may use inventory as a pledge. Lenders determine a business’s eligibility by assessing resale value and turnover rates.
When Should You Use Collateral?
Offering collateral will be most effective if the purpose is securing more favorable terms or better prices. Businesses requiring loans for the purpose of upgrading equipment, expanding facilities, or stabilizing working capital might see this as the best way to get a business loan. A collateral-based loan is most suitable if:
- Your business credit score is average or below ideal.
- Your firm is relatively young or lacks sufficient operating history.
- You need a higher loan amount than that which unsecured lending will allow.
- You would like predictable monthly payments with fixed interest rates.
Even those entrepreneurs who apply for instant small business loans can benefit from collateral, as the collateral pledged may speed up the processing of their loans with better terms than unsecured loans.
How to Prepare Your Collateral for Lenders
The best way to get a business loan is to properly prepare your collateral, as this increases the trust of the lender and enhances their security. Below are some easy ways to get ready:
- Be Prepared to Invest in an Appraisal: Lenders typically request appraisals for most types of collateral to ensure that they have accurate values before approving loans. Providing lenders with confusing, inflated, or inaccurate appraisals will cause delays or disqualify you from being considered for a loan.
- Provide All Documentation Required by Lender: When applying for loan approval, it is essential to provide the lender with all relevant collateral documentation, including ownership and transfer documents, lease agreements, maintenance records, and records indicating business liability insurance coverage.
- Understand Loan-to-Value (LTV) Ratios: LTV ratios are the percentages that lenders typically approve against the value of your collateral. The amount of funding you can expect to receive is related to the collateral’s LTV percentage. The LTV ratio also determines how much funding you can realistically expect to receive without needing to go through additional loan applications.
- Be Upfront About the Condition of Your Collateral: Being upfront and honest about any issues related to wear, depreciation, and previous damage to your collateral creates confidence in lenders and helps expedite the underwriting process. If significant defects in the collateral are identified during the due diligence phase of the loan application process, it will take longer to approve the loan.
Conclusion
Being aware of how you can leverage your assets will serve as the best way to get a business loan with more favorable terms. Although there may be some collateral risk, proper preparation will do much for securing approval. By selecting the proper assets to pledge, as well as providing proper financial documentation, those seeking a loan can increase lender confidence, so this is considered the best way to get a business loan that will provide the most effective interest rates.
