Collateral
Lenders require collateral for a secured loan to minimize the risks. The lender will want to match the collateral with the type loan being made to ensure the security of the loan. The life of the collateral will need to meet or exceed the term of the loan. Not meeting or exceeding the loan terms will jeopardize the lenders secured interest. Short-term assets such as accounts receivables and inventory are not acceptable as security for a long-term loan.
Most lenders will require that their claim (to the collateral) be first. Lenders want no prior or superior liens to exist, to be created afterward, or to be against the collateral being used. By being a priority lien holder, the lender ensures its stake of any foreclosure proceeds before any other claimant.
A common source of collateral is the equity value in real estate. The borrower may need to take out a new, or second, mortgage on their residence. Be aware that in some states, a lender can protect their interest in real estate by keeping the title to the property until the mortgage is paid off.
Lenders further limit their risks by discounting the value of the collateral. They do this so they are not taking on 100 percent of the collateral's highest market value in risk. The relationship between the amount of money loaned and the value of the collateral is called the loan-to-value ratio. Banks use different loan-to-value ratios depending upon the type of collateral being pledged. A typical example is that unimproved real estate will yield a lower loan-to-value than improved real estate. These ratios can and will vary between lenders. Other lending criteria may also influence the loan-to-value ratio. For example, a good cash flow history may permit for more flexibility. A typical listing of loan-to-value ratios for the different types of collateral accepted at a small community bank is:
- Inventory - Lenders might give 60 percent to 80 percent of face
value for retail inventory. A manufacturer's inventory, which consists
of both component parts and unfinished materials, will be valued much
lower. The key factor is how fast and for how much money can the
merchandise be sold for.
- Real estate - Lenders might provide up to 75 percent of the
appraised value if the real estate is occupied. If the property is
improved, but not occupied, lenders might give up to 50 percent. For
vacant and unimproved property, the standard is around 30 percent.
- Accounts receivable: Lenders will typically pay up to 75 percent on
accounts that are less than 30 days old. Accounts receivable are usually
"aged" by the borrower before any value is given to them. Few lenders
don't pay attention to the age of the accounts until they are
outstanding for over 90 days. When they are older than 90 days, almost
all lenders will refuse to finance them. Some lenders have a graduated
scale to value accounts. For example, accounts that are from 31-60 days
old may have a loan-to-value ratio of 60 percent, and accounts from
61-90 days old may have a loan-to-value ratio of 30 percent.
Delinquencies in the accounts and the overall creditworthiness of the
account debtors may also affect the loan-to-value ratio.
- Equipment: If the equipment is new, the bank might agree to lend 75
percent of the purchase price. If the equipment is old/used then a lower
percentage of the appraised value will be calculated.
- Securities: Lenders will allow marketable stocks and bonds to be used as collateral. They typically give up to 75 percent of the market value. One standard stipulation for the loan is that the loan proceeds cannot be used to purchase more stock.
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© 2001 Missouri Innovation Center