What is collateral and do I need it for a business loan?
Collateral may help business owners secure a business loan, but it is not always required. Learn more about what collateral is and when lenders may require it. Presented by Chase for Business.
- Collateral is an asset that a business provides to secure a loan.
- While collateral isn't necessary for every business loan, providing it may help improve your approval chances or help you get better interest rates.
- What qualifies as collateral may differ between lenders and alternatives to collateral (like personal guarantees) may be required in some cases.
Understanding the basics of business loans may be helpful if you’re considering financing options for your company. Collateral is a common consideration when discussing business loans.
This article explains what collateral is, when it’s generally needed for a business loan, common types of collateral and what to keep in mind if you’re seeking funding without collateral or a personal guarantee.
What is collateral?
Collateral is an asset that a borrower uses to back a loan as security. If a loan requires collateral, it is considered a secured loan. In this case, if the borrower fails to repay, the lender can claim the collateral to recover the outstanding balance. But to lenders, collateral is more than just putting up assets; it also signals your commitment and capacity to repay the loan.
With business loans, collateral offers protection to the lender and may also help the borrower secure better loan terms, like lower rates or larger loan amounts. The specific value and type of collateral often depend on the loan size, the lender’s requirements and your business’s financial situation.
When does a business loan need collateral?
Whether or not a business loan needs collateral depends on several elements, such as lender policies, the type of loan and your business’s financial strength.
Many standard loans—including term loans and equipment financing—generally request collateral to limit lender risk. However, some types may not require collateral at all. This is more common with unsecured lines of credit or certain small business loans. In those cases, lenders may focus on your creditworthiness, business income or overall financial performance.
Situations where lenders might require collateral include:
- Your business is new or lacks a proven track record.
- The loan amount is sizable compared to your business’s assets or cash flow.
- The company’s credit history is limited or business credit scores are lower.
- A lender’s internal policies mandate collateral as part of their risk evaluation.
There are also loan options for borrowers who prefer minimal or no collateral requirements, but these might come with higher rates or tougher approval standards.
What can be used as collateral for business loans?
Lenders usually accept a range of assets as collateral for business loans. The kind of collateral permitted depends on the lender’s preferences and the intended use of the loan.
Common types of collateral include:
- Real estate: Commercial buildings, property or land held by the business
- Equipment: Machinery, vehicles or business technology
- Inventory: Goods or merchandise the business intends to sell
- Accounts receivable: Customer invoices or outstanding amounts owed to the business
- Cash or savings: Business savings or certificates of deposit
- Securities: Stocks, bonds or investment portfolios owned by your business
Lenders typically determine the value of collateral based on current market prices and often lend up to only a set percentage of the asset's value, known as the loan-to-value (LTV) ratio.
Collateral vs. personal guarantee for business loans
Collateral and personal guarantees are both used to secure business loans, but they work differently.
Collateral assigns the loan to specific assets. If you fail to repay the business loan, the lender can seize that collateral, though your personal assets are usually not affected unless you use them as collateral.
A personal guarantee is a pledge to personally repay the loan if your business can’t. In this case, the lender may be able to pursue your personal assets—such as a home or personal accounts—if you default. Some loans may require both collateral and a personal guarantee, while others need just one or the other.
Knowing how these two forms of security work can help you weigh the risks associated with various loan options.
Can you get a business line of credit with no personal guarantee?
The following are some scenarios where business owners may be able to secure a business line of credit without a personal guarantee:
- Strong business history: Lenders may waive the requirement for established businesses with solid financials and longevity.
- Excellent credit: Building a high business credit score may help you qualify for unsecured credit.
- Lower credit limits: Some lending options provide small credit lines without personal guarantees, typically on a lower scale.
- Alternative lenders: Certain fintech or online lenders may offer unsecured products, though their interest rates may be higher than average.
Before securing a business loan, it can be helpful to review the loan terms closely and understand any fees and obligations. Securing a loan without collateral or a personal guarantee usually requires evidence of strong financial performance and creditworthiness. Speaking with a business banker can help you review your unique assets, cash flow and goals to find the financing solution that best fits your business.
Frequently asked questions
Do all business loans require collateral?
No. Some business loans are unsecured and don’t need collateral, though these often have stricter requirements or higher interest rates.
How do lenders decide if collateral is required?
Lenders review factors like loan size, your business credit profile, loan type and overall risk when determining collateral requirements.
Can I use unpaid customer invoices as collateral for a business loan?
Yes, many lenders accept accounts receivable as collateral to help secure a line of credit or term loan. This may be a helpful option for service-based businesses that lack physical assets like real estate or heavy machinery.
Does the equipment I am buying serve as its own collateral?
In most equipment financing agreements, the machinery or technology you purchase acts as the collateral for that specific loan. This means you may not need to pledge additional business or personal assets to secure the funding.
Will I always have to put my house up as collateral for a business loan?
No, you do not always have to pledge personal real estate to secure business funding. However, if your business lacks sufficient assets or a strong credit history, a lender might require a personal guarantee that could put your personal assets at risk if you default.
