Providing collateral to secure a loan
When it comes to obtaining a secured loan, providing collateral is a must. To a bank, collateral is simply defined as property that secures a loan or other debt, so that the lender may be seize that property if the you fail to make proper payments on the loan.
Understanding your collateral options
When lenders demand collateral for a secured loan, they are seeking to minimize the risks of extending credit. In order to ensure that the particular collateral provides appropriate security, the lender will want to match the type of collateral with the loan being made.
The useful life of the collateral will typically have to exceed, or at least meet, the term of the loan. Otherwise, the lender’s secured interest would be jeopardized. Consequently, short-term assets such as receivables and inventory will not be acceptable as security for a long-term loan, but they are appropriate for short-term financing such as a line of credit.
In addition, many lenders will require that their claim to the collateral be a first secured interest, meaning that no prior or superior liens exist, or may be subsequently created, against the collateral. By being a priority lien holder, the lender ensures its share of any foreclosure proceeds before any other claimant is entitled to any money.
Protecting your collateral
Properly recorded security interests in real estate or personal property are matters of public record. Because https://www.paydayloansohio.net/cities/addyston/ a creditor wants to have a priority claim against the collateral being offered to secure the loan, the creditor will search the public records to make sure that prior claims have not been filed against the collateral.
If the collateral is real estate, the search of public records is often done by a title insurance company. The company prepares a “title report” that reveals any pre-existing recorded secured interests or other title defects.
If the loan is secured by personal property, the creditor typically runs a “U.C.C. search” of the public records to reveal any pre-existing claims. The costs of a title search or a U.C.C. search is often passed on to the prospective borrower as part of the loan closing costs. In startup businesses, a commonly used source of collateral is the equity value in real estate. The borrower may simply take out a new, or second, mortgage on his or her residence. In some states, the lender can protect a security interest in real estate by retaining title to the property until the mortgage is fully paid.
Determining a loan-to-value ration
To further limit their risks, lenders usually discount the value of the collateral so that they are not extending 100 percent of the collateral’s highest ount of money the bank lends to the value of the collateral is called the loan-to-value ratio. The type of collateral used to secure the loan will affect the bank’s acceptable loan-to-value ratio. For example, unimproved real estate will yield a lower ratio than improved, occupied real estate. These ratios can vary between lenders and the ratio may also be influenced by lending criteria other than the value of the collateral. Your healthy cash flow may allow for more leeway in the loan-to-value ratio. A representative listing of loan-to-value ratios for different collateral at a small community bank is:
- Real estate: If the real estate is occupied, the lender might provide up to 75 percent of the appraised value. If the property is improved, but not occupied, such as a planned new residential subdivision with sewer and water but no homes yet, up to 50 percent. For vacant and unimproved property, 30 percent.