Sep 22, 2022
Whether you’re looking to grow your business or buy a franchise, you may need to take out a Small Business Administration or SBA loan. An SBA loan can help you get started if you don’t have enough cash on hand.
But what collateral will you need to secure one of these loans? How much equity do you need to prove? And how much can you borrow? Find out more in this complete guide on how much equity and collateral are needed for SBA business loans.
Collateral refers to property pledged as security for the repayment of a debt or the performance of some other obligation. That property can be anything from your home to a family heirloom. To put simply, you agree to let your creditor take possession of it if you don't pay up on time.
In case of SBA loans, the business owner must provide collateral to ensure the government will get repaid, when they take out a loan. There are many types of collateral that can be used such as: real estate, equipment, furniture, inventory, etc. The amount of equity you have in your business is how much cash you currently have invested in it.
When applying for a loan, how much collateral you need is highly dependent on the amount of money you're requesting, the type of loan, your credit history, and many other factors. Generally speaking, lenders will require more collateral when it comes to lending business owners a larger sum of money.
As an example, if you want to take out a $5000 business loan, you may have to provide $5000 in collateral. Lenders can be more willing to lend to you if you pledge assets that exceed or match the funding your business needs.
In terms of collateral, there's another important factor to consider. The definition of value is subjective in this case because it may differ for the lender. Let's say you want to pledge $5000 worth of property as collateral to secure a business loan. Most lenders will not give you credit for the full appraisal value.
Lenders might instead view the property as worth 80% to 90% of its appraised value just incase they can't sell it for its full value. The amount of money your business can borrow can be affected by this discounting of value. Your collateral would only be worth $4000 if a lender only accepts 80% of your property's value in the example above.
There are various types of business loan collateral. Some of these are:
One type of collateral that can serve as SBA loan collateral is real estate. Real estate encompasses a lot more than just the land, it includes both raw and finished improvements such as structures, machinery, and inventories.
Owning real estate as an asset makes it easier for SBA lenders to provide loans. It is because they can sell the property in case the business owner defaults on the loans.
Equipment is a popular type of collateral that many lending institutions will accept. Equipment can include computers, vehicles, office equipment, and manufacturing machinery among other items.
A major downside to equipment as a type of security is the speed at which it depreciates due to regular use. This can create financial problems for some borrowers if they are unable to repay their loans on time.
Cash is one of the most common forms of collateral for a business. To use it as collateral, you'll need to show that you have a bank account with an ample balance. With this type of collateral, the lender will deduct your funds from your account and assume ownership if you fail to make the payments.
If you want to finance your business without providing collateral, then you can do it. Lenders take a larger risk with unsecured business loans that don't require collateral. Therefore, some trade-offs may occur, including:
There could be fewer lenders to choose from- Lenders might not be willing to lend you money if you want an unsecured business loan. Unsecured business loans may be better accessed through online lenders, by comparison. It is possible, however, that you will be required to make a personal guarantee to protect the lender in case of a default.
Credit might be a requirement- When you apply for a business loan, lenders often consider your business credit score as well as your personal credit score. Traditional lenders may have stricter credit criteria for unsecured business loans, especially if you pledge assets.
Loan terms and interest rates may be less attractive- Lenders are more likely to take risks with unsecured loans. This may result in the lender charging you more, lending you less money, or requiring a larger down payment.
It is true that SBA loans require a down payment. A down payment of 10% is common, but it will vary depending on the loan and borrower. In some cases, this amount can reach 20%. However, there might be a few options in SBA loans where you don’t need to make down payment.
Personal use of SBA loans is not permitted. You can only use the funds for your business. The expenses you incur in running your business, expanding your business, and paying salaries to employees, are included in this category. It is not possible to use an SBA loan to pay off personal debts, such as mortgages or credit card bills.
We have highlighted a general guideline for how much equity and collateral your business needs for an SBA loan. The requirements for each lender can vary, so it's important that you consult with your lender to determine what their minimum requirements are.
The good news is you can still get help if your credit score is not good. For assistance in getting small business loans, please contact Royale Capital.