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Collateral is a major component of your entire deal. The type of collateral you choose to support your loan will directly impact your interest rate, length of term, and overall costs associated with the loan. A home generally provides significantly better terms than a truck or a bunch of inventory.
So your choice of collateral shouldn't be viewed lightly. Your collateral selection can represent the difference between an average loan and a superior loan. I've been helping small and midsize business owners get financing for more than 15 years. Without fail, the strength and consistency of your collateral determines the quality of your lender's loan terms.
Below, we examine what constitutes collateral, what types of collateral provide the most competitive pricing, and what risks are involved in pledging collateral.
What Is Collateral?
Collateral is an asset you pledge to a lender to protect them in case you default on the loan. Lenders don't lend money to everyone who applies. They require collateral to reduce their risk of loss. If you can't repay the loan, the lender will take possession of the collateral and sell it to recover their losses. To protect themselves, lenders create a security interest in your asset. This is a legally binding agreement that lets them seize your asset if you default on the loan. By reducing the lender's risk, secured loans are typically priced lower than unsecured loans.
The type of loan you get often corresponds to the nature of your collateral. A mortgage is secured by real estate. Auto loans are secured by automobiles. Business loans may be secured by equipment or outstanding accounts receivable. The purpose of securing a loan is to give the lender an asset they believe will hold enough value to cover their losses if you default. When it does, lenders see the loan as less risky, so they may approve a larger loan or offer better pricing.
Examples of Collateral
As shown below, various types of assets may serve as collateral for loans. As a rule, the value and stability of the asset used as collateral will determine how favorable your loan terms are. The types of collateral commonly used by lenders include:
Real estate
Real estate serves as one of the most frequent and valuable types of collateral for loans. Since property holds significant value and can be sold relatively quickly, lenders view it as low risk. A business owner may pledge a warehouse as collateral for a loan, while a homeowner pledges their house as collateral for a mortgage.
Vehicles
Vehicles such as cars and trucks serve as collateral for auto loans, personal loans, or business loans. If you default on a loan, the lender may repossess the vehicle and resell it to recoup their losses. Vehicles depreciate more rapidly than real estate, but they remain a popular form of collateral among lenders. Companies may pledge their delivery trucks to get short-term financing, while an individual may pledge their vehicle to receive reduced interest rates for secured personal loans.
Cash and investment accounts
Cash accounts including savings accounts and certificates of deposit, as well as investment accounts such as stocks and bonds, serve as excellent collateral due to their liquidity. When you pledge a financial account as collateral for a loan, you'll generally receive lower interest rates, since lenders assume minimal risk when lending against liquid assets.
Business assets and equipment
Businesses frequently pledge equipment, inventory, and accounts receivable to secure loans. Manufacturers may pledge their equipment to secure a working capital loan, while retailers may pledge their inventory and outstanding accounts receivable to get quick funding via invoice factoring.
Other high-value personal property
Some lenders also accept high-value personal property such as jewelry, artwork, and insurance policies with cash values as collateral. These collateral arrangements are infrequently used for business financing, and generally result in limited funding, since it can be difficult to assess the value of many such assets or sell them quickly.
Personal Real Estate or Home Equity
This is another example of personal real estate, specifically the equity in your home. Equity refers to the portion of your home that you actually own, essentially its value minus the balance remaining on your mortgage. A home equity line of credit (HELOC) lets homeowners access funds tied up in their home equity. HELOCs function similarly to revolving credit cards. Borrowers can draw on funds as needed, then repay the funds drawn before drawing again.
HELOC is a way to borrow money using the available equity in your home. Our business HELOC is available starting at prime, which is 6.75% today.
Keep in mind, though, that your home is being offered as collateral. If you can't repay your loan, the lender may seek foreclosure on your home, which is a substantial risk. So, before agreeing to place your home under any loan, discuss it further with a lending advisor.
Minimum Qualifications
$10,000 in monthly revenue
Your business must earn at least $10K per month in a business bank account.
500+ credit score
You can get approved with any credit score. But the better your credit rating, the better interest rates lenders offer. Your FICO score should be above 500.
Minimum six months in business
Your company should be operational for a minimum of six months. This shows business lenders that your company is sustainable and won't go out of business.
Have a business bank account
Your Clarify advisor will need three or four months of your most recent bank statements to verify income. This is just to see you're actually making $10K+ month in revenue.
How Collateral Impacts Your Loan Terms
A secured loan supported by solid collateral typically receives better loan terms than an unsecured loan supported by no collateral. Typically, this results in lower APRs, higher borrowing limits, and more flexible repayment schedules. Unsecured loans tend to have higher APRs because no asset supports the loan, so there's no recourse for the lender if you stop making payments.
Your credit remains important whether you're applying for a secured or unsecured loan. Either way, lenders will check your credit profile. Still, pledging a highly valued asset such as real estate or a cash account will likely improve the terms you receive.
Among all types of collateral available for pledging, real estate and cash accounts historically produce the most competitive pricing and greatest likelihood of approval, thanks to their tendency to hold value and how quickly a lender can recover them if a borrower defaults.
The Risks of Pledging Collateral
Although pledging collateral can improve your loan opportunities, there are several risks that come with placing your assets on the line. The main risk is forfeiting your asset. If you default on a secured loan, the lender has the authority to seize your pledged asset and sell it to offset their losses. With a HELOC, forfeiting your home would happen if you defaulted on repaying your loan. So consider carefully whether pledging an asset jeopardizes the survival of your business or places excessive strain on your current cash position.
Alternatives To Using Collateral
While pledging an asset can help you get financing at more competitive pricing, it's possible you may not have an asset suitable for collateral, or simply prefer not to use one at all. Fortunately, there are alternatives that focus on your business operations and profitability rather than tangible assets pledged as collateral.
| Option | Description |
|---|---|
| Unsecured business loans | These financing options don't require any form of collateral, so they're accessible to businesses without considerable assets. |
| Lines of credit | Business lines of credit are revolving credit you can draw on as needed, based on your business performance rather than any specific asset pledged. |
| Working capital loans | Working capital loans are designed to give businesses funds for ongoing operating expenses. They're based on the revenue a business generates rather than an asset pledged. |
| Merchant cash advances | Merchant cash advances are funded based on anticipated future earnings from card transactions. Merchants make regular repayments on their outstanding balances as they generate revenue. |
Get Better Loan Terms With Clarify Capital
Using the right collateral can impact your loan terms. Choosing an appropriate asset can lower your interest rates and improve your chances for approval.
You don't necessarily need to pledge an asset to receive good terms, though. Clarify Capital offers multiple options where revenue is evaluated instead of requiring an asset as collateral. To look at revenue-based financing that doesn't require collateral, apply today. It only takes two minutes.
FAQs on Collateral
Still have questions on this financing type? Here are the answers to some of the most common questions I hear from borrowers.
What Is a Collateral Loan?
A collateral loan is any loan supported by an asset you pledge, such as your home, vehicle, cash account, or business equipment. Since pledging an asset reduces a lender's perceived risk, most lenders extend better pricing (lower interest rates and larger borrowing capacities) when accepting assets as collateral for secured personal loans and secured business loans. If you default on a secured loan, lenders can recover their losses from the sale of pledged assets.
Do You Need Collateral for a $20K Loan?
Not necessarily. Many lenders offer unsecured loans exceeding $20,000 based on your creditworthiness and revenue rather than an asset pledged as collateral. Many lenders look at your debt-to-income ratio, which compares what you owe to what you bring in, along with factors like time in business. While pledging an asset may improve your pricing, you can receive good terms without one if you meet the lender's minimum qualifications.
What Are the Dangers of Pledging Collateral?
Mainly, pledging collateral exposes you to losing that asset if you default on your secured loan. When you fail to repay, lenders acquire ownership rights to the pledged asset and sell it to collect what they're owed. For example, if you pledge your home as collateral for a HELOC and then default on repaying it, lenders will pursue foreclosure on that same home.
Can I Release Collateral From an Existing Loan?
Yes. Once you've satisfied an existing secured loan, lenders will remove their claim on the asset, often by releasing the lien filed with the original loan agreement. Some lenders also allow you to swap in a new asset or release the collateral early once you've met certain conditions in the agreement. Those options have to be worked out individually with the lender.
Are Collateral Loans a Good Idea?
Generally, yes. If you have stable assets and want the best pricing you can get on a secured loan, it's worth considering pledging an asset when you're seeking financing. Paying off a secured loan on time can also help strengthen your credit rating going forward, which earns you better terms on future financing.
How Can I Improve My Credit Rating Through a Collateral Loan?
The simplest way to improve your credit rating with a secured loan is to consistently make every scheduled payment on time. Both secured loans and secured credit cards backed by a cash deposit report your payment activity to the credit bureaus. Consistent payment behavior strengthens your credit and ultimately improves your credit score, which helps you get better pricing on future financing.
Does Clarify Capital Protect My Information?
Clarify follows SOC 2 security principles, so the bank statements and tax returns you send stay protected through the review. Checking your options will not affect your credit score, because the lender's first look at your credit is a soft pull, not a hard inquiry.
Michael Baynes
Co-founder, Clarify
Michael has over 15 years of experience in the business finance industry working directly with entrepreneurs. He co-founded Clarify Capital with the mission to cut through the noise in the finance industry by providing fast funding and clear answers. He holds dual degrees in Accounting and Finance from the Kelley School of Business at Indiana University. More about the Clarify team →
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