It’s a fact: to be successful in business, sometimes you have to borrow money to maintain a stable cash flow. But what do you do if you have bad credit? What business financing options do you have
Do not worry. Even if your business and personal credit ratings are too low to qualify for traditional business financing, you may still qualify for a secured business loan from the right lender, also known as a secured business loan.
What is a secured business loan?
Collateral is an asset, which is anything of value that you can pledge against a loan. We’ll cover what can be used as collateral in the next section, but here’s what you need to understand about collateral and asset-based financing.
Having a high-value asset gives the bank something to take and sell if you can’t repay your loan. This reduces the bank’s risk, making them more likely to approve you for a loan.
Here’s an example: Let’s say you want to borrow $50,000 and you have equipment worth $85,000. You pledge the equipment as collateral and get the money. One day you realize you will never be able to repay the loan and you default. The bank can then seize this equipment and sell it to cover what you owe. If the bank gets more than you owe, they’ll keep it too.
Generally, banks want collateral that is easy to liquidate or convert to cash. It’s easier for lenders to offer you financing when the collateral is heavy equipment like dump trucks or tractor-trailers that can easily be sold than real estate that can take months or months to sell. years.
As with any type of bank loansyou will benefit from repayment terms and, assuming you make all your monthly payments on time, you will also strengthen your business credit.
What is used as collateral for a business loan?
There are several categories of assets you can use for your secured loan, including:
- Paper assets
- Sustainable assets
- Future income
- Personal property
- Heavy equipment
A lender loves it when you have paper assets like cash, CDs, or stocks that can be used as assets against your loan. These are the easiest to liquidate.
Durable assets must be sold and their value is less determined. This includes things like equipment, vehicles, buildings, and inventory.
You can also pledge your future earnings as collateral. Your bills and accounts receivable have value, although there’s no guarantee the lender can collect them, so you may pay a higher annual percentage rate to get your money.
If you don’t have any of the above in your business, you may need to give a personal guarantee with something you own, like your car or house.
If you don’t qualify for an unsecured business loan, consider what you need to post as collateral against the loan.
Collateral by type of commercial loan
There are several types of secured loans for small business, so find the one that best suits your needs. Some commercial lenders focus on certain types of loans, while others offer multiple options. What they all have in common is that you will need to secure the loan with your asset(s).
In most cases, you will need to provide collateral for an SBA loan. If your business does not have adequate assets, your personal assets will be considered. However, and this is important to know: the SBA loan guarantee is not always required. If your loan application looks good other than that you have no assets, you may still be approved as a borrower.
It is also important to note that the SBA loan to collateral value ratio is decided by the lender, not the SBA. So one bank may rate the amount of money you are entitled to borrow as less than another.
There are several types of SBA loans to consider, in particular:
- 7(a) ready
- 504 ready
- SBA express loan
- Veterans Advantage Loan
For banks, collateral is one of the 5Cin the same way:
In addition to the bank loan guarantee you have in place, a bank lender will carefully review your credit scores (check your free credit scores for businesses so you know where you stand before you apply).
As I said before, each lender may define the loan to value ratio of your bank guarantee differently when applying for a loan, so be comfortable with the value you have been given before you agree to borrow. money.
Commercial real estate loans
If you have equity in commercial real estate that you own, this can be used as personal collateral. It’s like taking out a mortgage on your home to use the money to renovate it: you use your commercial real estate loan collateral to get the funds you need to expand, build or renovate your property.
The loan to value ratio for commercial real estate is determined by dividing the loan amount by the appraised value of the property. So if you have a building worth $1 million and you want a loan of $600,000, the loan-to-value ratio (or LTV) would be 60%. The lower the LTV, the better terms and reimbursement rates you can get.
Another option where you can use collateral to obtain credit is with equipment financing. Your equipment loan guarantee is integrated: it’s the equipment you buy!
Because equipment depreciates quickly, the loan-to-value ratio of loaning equipment is often lower than that of other assets, at around 50%.
Many companies opt to rent equipment because it loses value so quickly, so this is another option to consider.
Another lending option with the embedded asset is the inventory loan. Let’s say you’re selling cars and you want to buy 20 of them. That’s a lot of money, but if you use those cars as inventory loan collateral, the bank will be happy and you can get the money you have. needed to make the purchase.
Typically, the loan-to-value ratio of your inventory loan collateral will be around 50-80% of the value of your inventory. Some stocks are easier for a bank to sell than others, which will affect the value it assigns.
Loans on invoice
If you run a business that requires you to send invoices to customers, invoice financing might be a good fit. Your invoice loan collateral is the value of the invoices themselves: you borrow against the value of the invoices to be paid in the future. Once you are paid, you repay your loan.
Another option is invoice factoring. Rather than managing your bills as a borrower, you essentially sell your bills to the lender and they take care of getting them paid while giving you the money you need.
The loan to value ratio of the invoice loan guarantee is usually 50-80% of the invoice.
Loans to private investors
If you choose to borrow from a private lender, you may also need to provide collateral. Since you are not going through a traditional funding channel, the collateral requirements for loans to private investors may vary, as can the loan-to-value ratio of loans collateralizing loans to private investors.
Benefits of Secured Business Loans
There are many benefits you reap when you borrow money using collateral.
If your personal or business credit score isn’t that high, you can still get the financing you need from a lender willing to offer you a secured loan. If you don’t know what your trade credit looks like, take a look at your business credit report.
If you have a poor or non-existent credit history, taking out a secured loan will help you build your credit so you continue to get better terms each time you apply for financing.
While cash loans, business credit cardsor merchant cash advance loans often have higher interest rates, because you put up an asset with a business loan as collateral, you can usually get better terms.
You also have high approval chances, assuming the loan-to-value ratio is low. And, depending on the value of your collateral, you may be eligible for higher financing amounts.
Disadvantages of Secured Business Loans
Although secured small business loans may be suitable for many entrepreneurs, there are also disadvantages that you should be aware of.
The application process can be lengthy, in part because the lender must assess the value of your collateral. And not all guarantees can be used: there must be significant equity and value in the guarantee you offer.
You pledge your assets as personal collateral, so you have the potential to lose what’s important to you.
Your business could receive a UCC deposit following the purchase of asset-based corporate financing. This is a legal notice filed with the Secretary of State stating that the lender has an interest (or lien) in the asset you are using to obtain financing. This will show up on your credit report and, if not handled appropriately by the lender, could prevent you from obtaining further financing later on.
The cost could be higher than with traditional business loans, so if you qualify for one, this should be your first choice.
Your business cannot thrive without cash flow. If you need working capital, borrow wisely. If you don’t qualify for other financing options because of your credit history, borrow against assets you already own.
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