What is Collateral?
Menaye Finance Tips
Boost Loan Approval: Use assets like a house or car as collateral to increase your chances of getting a larger loan.
Understand the Risk: If you can’t repay the loan, the lender can take and sell your collateral to recover their money.
Know the Value: Ensure your collateral is worth enough to cover the loan; typically, it should be worth 150% of the loan amount.
Suitable Assets: Not all assets are suitable as collateral. Lenders usually don’t accept perishable items or assets that quickly lose value, like fresh produce or electronic gadgets, as collateral.
When lending money to a business, the bank or lender may request collateral, such as a house, to increase their confidence in approving a larger loan. Collateral serves as security for the lender, ensuring that if the borrower cannot repay the loan, the lender can sell the collateral to recover their funds.
Not all loans need something valuable as security. Some loans, like those designed for women-led businesses or small and medium-scale enterprises, are approved based on your credit history and income without requiring any assets. However, these loans might have limits on how much you can borrow.
How Collateral Works:
Pledge of Asset: When you take out a loan with collateral, you agree to pledge a specific asset, such as a car, house, or investment account, as collateral. This pledge is documented in the loan agreement.
Security for Lender: The collateral provides security for the lender. If you default on the loan (stop making your payments), the lender has the legal right to take possession of the collateral and sell it.
Reduced Risk for Lender: By having collateral, the lender reduces their risk of loss. Even if a borrower defaults, they can recover some or all the loan amount by selling the collateral.
Legal Registration of Collateral: After the bank completes the legal process through the land registry to secure the property as a legal mortgage, records of the collateral are maintained. The bank registers its interest in the property at the Collateral Registry, where other lenders can also search for registered security interests.
Common Types of Collateral:
Real Estate Collateral:
Real estate is frequently used as collateral for mortgages. Banks may also accept commercial properties or personal real estate assets—like houses or land in prime locations—as collateral from business owners.
Vehicles:
For auto loans, the car itself is typically the collateral.
Investment Accounts as Collateral:
Securities in a brokerage account, including stocks or bonds and funds in treasury bills or fixed deposit accounts, can serve as collateral for specific types of loans.
Collateralizing Business Assets:
Businesses have the option to use various assets as collateral for loans. These can include equipment, inventory, or accounts receivable (the money customers owe to the business).
