How to Use Collateral

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Collateral is a powerful asset that, if used properly, can enable a borrower to secure a loan with attractive terms. Collateral is property that a borrower pledges to a lender in order to secure a loan. Loans are typically offered at a percentage of the value of the collateral. For example, if you intend to pledge a car worth $1,000 and a bank will offer a loan at 85% of the collateral value, you will be able to secure a loan of $850. Because collateral typically consists of tangible assets that have concrete value, the use of collateral makes a loan less risky and will therefore allow borrowers to secure loans at lower interest rates.

Determine a value for the assets you intend to use as collateral. If your assets have a market value (such as stocks, bonds or other liquid securities), your most recent brokerage statement will suffice. If you intend to use harder-to-value assets, such as a building or land, you should hire an appraisal firm to determine the value of the assets.

Contact a number of different banks and request to speak with a loan officer. You should talk to some of the major banks--such as Chase, Bank of America and Wells Fargo--as well as regional banks and credit unions in your area. Inform the loan officer that you wish to secure an asset-based loan.

Fill out the loan application that the loan officer provides. You will need to enter your Social Security number, address and phone number, and you may need to include information about your previous work history. You will also need to attach a copy of your asset appraisal to the application.

Compare the loan offers that you receive from the various banks. Pay attention to the loan-to-value ratio, which is the ratio of the loan you are offered to the value of your collateral. If your collateral is valued at $1,000 and you are offered a loan of $650, the loan-to-value ratio is $650/$1,000 = 65%. Also pay attention to the interest rate you will have to pay and the length of the repayment period.

Negotiate the asset-based loan offers with the various lenders to secure a better deal. Make sure the banks give you full credit for the appraised value of your collateral (i.e. if the appraised value of your collateral is $1,000, make sure the banks have based their loans on this value rather than a lower, more conservative value). Play the different banks off against one another to ensure that you get the most attractive terms.

Tips & Warnings

  • Note that by pledging collateral to a bank, you are agreeing to surrender that collateral to the bank in the event that you default on your loan. Do not pledge prized assets if you think there is a good chance that you might default.
  • Be very cautious about pledging personal collateral (such as your house) for business loans. Many business owners pledge personal collateral to secure loans for their companies. However, a company's performance can easily be impacted by factors outside of your control, such as macroeconomic events.

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