Removing Confusion: A Simple Guide to the Steps Applying for a Secured Business Loan

What is a Secured Business Loan?

A secured business loan requires borrowers to pledge a form of collateral to back the loan. For example, equipment, real estate, and other valuable assets may be used as collateral to secure the loan. If the borrower doesn't repay according to the loan terms and defaults, the lender can take action to seize the collateral. Doing so helps lenders recover some or all of the remaining balance.

Unsecured business loans, on the other hand, don't require any collateral. In general, lenders focus on the borrower's creditworthiness and cash flow. Secured loans are less risky for a lender, which may lead to more favorable terms. Unsecured loans are riskier, often having strict underwriting criteria, and typically have higher interest rates.

Why Collateral May Help You Get a Small Business Loan

The fact is that many banks require collateral for business loans, and that likelihood increases with loan size. According to the 2024 FDIC Small Business Lending Survey, 99% of small banks and large banks require collateral for large loans, defined as $1 million or $3 million.

Medium loans of around $250,000 also have a high percentage of banks requiring collateral, including 97% of small banks and 89% of large banks. Even much smaller loans of $25,000 typically require collateral, with 81% of small banks and 55% of large banks requiring an asset to secure the loan.

These numbers illustrate why collateral is one of the main steps to getting a business loan. It provides more assurance to lenders, as they have a backup plan if borrowers fail to meet their repayment obligations. At the same time, collateral can also help borrowers receive better loan terms and enhance approval odds. Especially if your personal credit score is less than remarkable.

It's always a good idea to review your credit report for errors before going through the steps to getting a business loan. Through AnnualCreditReport.com, you can access credit reports from the major bureaus, such as Experian and Equifax.

Common Types of Collateral for Business Loans

Providing collateral is often one of the primary steps to getting a business loan. As a borrower, it's key to understand what you can pledge as collateral to secure a loan. In general, collateral is an asset that lenders can recover if a borrower doesn't repay the loan.

But there are different types of collateral, each with its own advantages and risk factors.

• Business equipment: If you get equipment financing, you have a built-in source of collateral. Generally, lenders want equipment that has a high resale value. Highly specialized equipment may be less desirable. Additionally, lenders consider depreciation and factor that into the equation.

• Real estate: If you have commercial property or own land, that may be used as a type of collateral. It can be easier to appraise and liquidate if necessary.

• Inventory: If you have a product-based business with high-demand goods, your inventory can be used as collateral. However, lenders must assess the value of the items, and some that are seasonal or perishable may not be a good fit.

• Accounts receivable: If you have outstanding invoices, you may also be able to use them as a form of collateral. Typically, lenders look at the customer's credit history to determine the likelihood of repayment. Some alternative financing options can include invoice factoring or invoice financing, which provide a set percentage of your unpaid invoices upfront after taking out fees.

• Cash or savings: If you have funds locked away in a business checking or savings account, that may be an eligible form of collateral. It's liquid, making it an appealing option for lenders, as it can go toward repaying the loan.

• Personal assets: If you don't have enough business assets, some lenders may require a personal guarantee. In other words, if the business assets are insufficient, then you are personally on the hook for the remaining loan balance. This could potentially put your home or vehicle at risk.

In general, lenders prefer forms of collateral that are essential to your business and have resale value. Understanding these various options is a major step when learning how to apply for a business loan. It may boost your chances of approval and could get you more favorable loan terms.

How Lenders Evaluate Collateral

Before we dive into the steps to getting a business loan, it's essential for small business owners to understand how lenders evaluate collateral. Here's a breakdown of some important factors that lenders consider with secured business loans.

• Ownership: Whether you're pledging a piece of equipment, real estate, or invoices, lenders want to verify that you're the rightful owner first. You may need to provide titles, deeds, or invoices to confirm ownership.

• Value: The main point of a secured loan is having an asset pledged in exchange for the loan. Lenders can then use that asset to recover funds if you fail to repay the loan. Because of that, lenders place a heavy emphasis on the current market value of your collateral. Depreciation, current condition, and supply and demand are all factors that can impact the value.

• Liquidity: If a lender needs to seize the collateral to satisfy the loan, it wants to make sure it can be easily sold. As a result, lenders consider the liquidity of the collateral as well as the resale value.

• Risk factors: Lenders will also evaluate the collateral's unique risk factors. This can include depreciation, demand, and convertibility into cash.

Understanding what lenders consider can help you prepare for applying for a secured business loan.

Steps to Getting a Business Loan Using Collateral

If you want to improve your chances of approval and get better terms, here are the steps to getting a business loan using collateral.

1. Determine your financing needs: The first step is to review your actual financing needs. Consider the loan amount, purpose, and how repayment would affect your cash flow.

2. Compare financing options: Based on your financing needs, review the different types of loans available to find the right fit. You can consider term loans from traditional banks and online lenders, SBA loans, business lines of credit, and equipment financing.

3. Review potential collateral: Take an inventory of which items may be available as collateral. Review ownership documentation, liens, and estimate the value of the item.

4. Research lenders: Once you know your desired loan amount and financing option, research lenders. Check out the eligibility requirements, repayment terms, Annual Percentage Rates (APR), potential down payment, and customer reviews.

5. Prepare documentation: As part of the application process, prepare your financial statements, tax returns, and title or deed for collateral.

6. Apply for a secured business loan: After you have your documentation and have chosen a lender, go through the application process. Typically, you'll provide information on your business and its financials, what you intend to use the loan for, and the amount requested, along with proof of collateral.

7. Lender review: One of the final steps to getting a business loan with collateral is lender review. Lenders will go through the underwriting process to make sure you qualify. If so, they'll also assess the value of your collateral.

8. Approval: If approved, you'll move forward with closing and receiving the funds. Then, you'll begin the repayment process. Remember to stay on top of your monthly payments to avoid putting your collateral at risk.

These eight steps to getting a business loan can streamline the process and help you prepare ahead of time.

Final Thoughts

If you have a new startup, secured business loans may increase your chances of approval and offer more competitive interest rates.

For established business owners, a secured business loan could provide more favorable terms and benefit both you and the lender. Regardless of your stage of business, the most important thing is to fully go through the steps to getting a business loan using collateral. Doing thorough research and understanding the value of your collateral before applying can help you navigate the process with ease.