Last Updated on November 23, 2021 by Opeyemi Quadri
Ever wondered why wealthy businessmen have easy access to loans? It’s because money lenders have brighter chances of recouping their money through the visible or invisible collateral they can provide.
The reverse is the case for an upcoming business owner, who struggles with office space, funds, and human capital. Banks hardly grant their loan request, when they do, only a pantry of the amount they need is granted.
Most times, it’s hard to blame the money lenders, they need not just an assurance that their investment would not be in vain, but an asset they can sell or put into use in case the borrower defaults.
Collateral in a simple term
In financial risk management, collateral is an asset or property offered by a borrower to a moneylender which would be forfeited if he fails to repay the loan.
It minimises the risk of the lender, it gives him an assurance that he won’t incur a total loss in case the borrow defaults on the terms of the loan.
Collateral is most important for mortgages and other secured loans (e.g foreclosure, non-recourse loans, and repossession).
In the banking sector, the value of the collateral is mostly evaluated by the risk management unit to be sure that it is worth the loan.
Mr Suyel applies for a $50,000 loan. He uses his 3-bedroom duplex which is valued at $70,000 as collateral.
Another applicant, Mr Greatness applies for a loan of $10,000 to support his business. But he only has a car valued at $5,600.
From the above individuals who want a loan from their bank, Mr. Suyel has a brighter chance that his application would receive an accelerated approval than Mr. Greatness.
In fact, Mr. Greatness’ loan application may be declined because if he defaults, the value of his car would not be enough to cover the bank’s loss.
That’s how important loan collateral is to financial institutions and other money lenders you can find around.
Does this apply to online loan?
Techbanking has redefined the way loans can be accessed, as such you may not need visible collateral to get approval from an online loan platform. But your application depends on many factors like:
- Loyalty to the platform
- Credit score,
- Employment status
- Activity on the loan app etc
Added to the above factors by financial institutions is your ability to make pledges that have value, they include:
- Real estate,
- Stocks and bonds
- Intangible and tangible properties are also accepted
- machinery and equipment
- investment funding,
- chattel paper,
- payment rights
So, here are the five types of loan collateral a bank will most likely ask from you before you could be considered eligible:
- Property In Relation To Real Estates
- Cash Security
- Lien on Asset
- Asset Debenture
- Inventory financing
Property In Relation To Real Estate
You can use your apartment as a guarantee to obtain a loan from a bank. It’s the oldest and commonest form of collateral acceptable by moneylenders.
If the property is undeveloped, then it must be located in an area where the value of land is impressive.
To use a property as loan collateral, you must be the rightful owner with evidence of ownership to include legitimate titles like:
- Governor’s Consent
- Certificate of Occupancy (C of O),
- Deed of Conveyance,
- Deed of Assignment,
- Deed of Gift,
- Deed of Sub-Lease etc
Lien on Asset
A lien is a claim on a property that a moneylender uses as collateral to make sure the borrower repays the money they borrowed.
For instance, a bank can hold the title of your apartment until you clear your mortgage or your car documents until you pay off your car loan.
An instrument used by a moneylender when providing capital to a borrower to enable the lender to secure loan repayments against the borrower’s assets (in case) he defaults is known as a debenture.
The borrower uses inventory as collateral. If he defaults, the items in the inventory can be sold by the money lender to cover its loss.
This is common among fast-moving consumer goods. The goods in the borrower’s warehouse are used as collateral, if he defaults, the borrower takes possession of the inventory.
This is the simplest form of collateral whereby the borrower takes a loan from a bank where he maintains active accounts, in an event of default the bank liquidates the borrower’s accounts to recoup the borrowed money. The loan under this arrangement is usually faster than others.