What collateral do you need to protect your loan business?

Collateral has been a key part of lending for centuries. In the past, people would borrow money and give the lender something valuable they owned, like animals, land, or expensive items, as a guarantee that they would pay the money back. This shows a basic need that lenders have always had: a way to make sure they get their money back if the borrower doesn’t repay the loan.

Although collateral items for loan have evolved and diversified over time with modern financial systems, the essence remains the same.

Collateral acts as a kind of safety net for lenders. It reduces the risk of losing money if a borrower doesn’t repay their loan. This allows lenders to  offer loans with more confidence, especially large ones or to people with less credit history.

Today’s lending world is full of choices, and there are many different things that borrowers can offer as collateral. Lenders need to be smart about what kind of collateral they accept, but they also want to make sure that all sorts of businesses and people have a chance to get the loans they need to grow.

Let’s take a look at what collaterals you need as a lender to protect your loan business.

Real estate

Real estate is a common and reliable form of collateral, especially for mortgage loans. In the United States alone, homes account for a total of US$47.5 trillion in value, making them a substantial asset class for lenders. On the home front here in Nigeria, residential real estate holds the largest share, with a projected market volume of US$1.93 trillion in 2024. If a borrower defaults on their mortgage, the lender has the right to foreclose, which means they can take possession of the property and sell it to recoup their losses.

Vehicles

Lenders consider several things when valuing a car or truck that’s offered as collateral. These include the year, make, model, how many miles it has on it, and its overall condition. A newer car with fewer miles and in good shape will generally be worth more than an older car with lots of miles and some dents or scratches. The car’s title should be clean, meaning there are no other loans or liens on it. This way, if the borrower doesn’t repay the loan, the lender can be confident they have the first right to sell the car to get their money back.

Equipment

Businesses can use the machinery, tools, and other specialized equipment they own as collateral for loans. Equipment generally loses value over time, just like a car. This is called depreciation. The lender needs to consider how much the equipment will be worth when they might need to sell it if the borrower doesn’t repay the loan.

Inventory

Businesses that sell physical products can use their stock of those products (their inventory) as collateral for a loan. The value of inventory can go up and down depending on what’s popular and what’s not, so lenders need to be careful about how much they lend based on inventory collateral.

Accounts receivable

Invoice factoring is a way for businesses to get cash quickly by selling their unpaid invoices to a company. The factoring company pays the business a discounted amount upfront, then collects the full amount from the customer later. This collateral can be attractive for lenders because they are financing invoices from creditworthy customers, who are likely not to default.

Financial assets

Cash in savings accounts, stocks traded on the market, and bonds are all easy to turn into cash quickly, making them good collateral for lenders. The value of these assets can change over time, so lenders typically only lend a portion (percentage) of the asset’s current market value.

Let’s look at what key things to consider when considering collaterals for a secured loan.

Figure out a fair market value of the collateral

Imagine you’re trying to sell something similar – how much would someone else pay for it today? Look at recent sales of things that are alike to get a good idea.

Also try to think ahead. Will the value of the collateral go up or down over time? For things like machinery, vehicles, or electronics, they tend to be worth less as they get older. Factor this in when deciding how much of a loan to offer.

Don’t forget to build a safety net for your loan business. Let’s say the collateral is worth #100,000. You might not want to lend the borrower the entire amount. Instead, you might lend them a percentage, like 70% or 80% (so #70,000 or #80,000). This cushion protects you in case the value goes down or there are unexpected costs involved with selling the collateral.

Figure out what collaterals are easy to sell

Questions you should have answers to before collecting a collateral are “how easy is it to sell?”, “how long would it take to find a buyer for the collateral if the borrower defaults on their loan?”. Things like specialized equipment might be harder to sell to someone else, so they are less liquid and could take longer to sell.This may affect what value you ascribe the collateral.

“Is the asset in a good condition fit for resale?”, “would it need repairs or upgrades before someone is willing to buy it?” This can affect how much you can realistically expect to get for it if you need to sell it.

Consider the legal aspects

Make sure ownership is indisputable. Collaterals must have clear titles with no pre-existing liens. Also factor in the process and cost of seizing different asset types. Ensure you perfect the legal rights to the collateral before a loan is given if not you may be embroiled in legal issues when try to lay claim to the collateral in the case of a default.

In all your lending, be smart

There are many different options for collateral items for a loan, from real estate and cars to equipment, business inventory, and even investments. The risks they reduce for lenders are quite substantial which makes it a fitting strategy for your loan business. You can approve loans more confidently especially for large amounts and to borrowers with less credit histories.

But it’s important for you to be smart about it. Think about how easy or stressful it’ll be to sell, can you even find someone to buy it, because if you don’t how would you get your money back? Collaterals are not for decorating your shelves. Don’t forget the legal headaches too.

At the end of the day, the goal is to protect your business and keep your lending system running smoothly, while giving people more access to credit. If you have questions on how Lendsqr loan management software can help run your business smoothly, simply reach out to [email protected].