The Pros and Cons of a Collateral Loan
Every business requires funding to grow, but not all businesses have the creditworthiness to obtain traditional loans. Collateral loans are a type of loan that requires you to put up something of value as security for the loan. If your business is struggling financially, you may be tempted to consider a collateral loan, but is it worth the risk?
Here are the pros and cons of a collateral loan so you can make an informed decision.
How Do Collateral Loans Work?
Collateral loans are secured by a specific asset that you own. For example, if you own a property, a vehicle, equipment, or any other valuable asset, you can use this as collateral to show the financial lender that you will pay the loan back. The lender will evaluate the value of the asset and determine the loan amount based on that value.
If you default on the loan, the lender has the right to seize the asset and sell it to recover the money. You will receive the difference if the asset is worth more than the loan amount. If the asset is worth less than the loan amount, you will be responsible for paying the difference.
Pros of a Collateral Loan
Here are some benefits of a collateral loan:
- Easier to qualify for: Since collateral loans are secured, lenders are more willing to approve them since they have something to fall back on if you default
- Lower interest rates: Collateral loans typically have lower interest rates than unsecured loans because they are less risky for lenders.
- Larger loan amounts: Because collateral loans are less risky for lenders, they are often willing to lend larger amounts of money than with unsecured loans.
- Flexible repayment terms: Collateral loans often have more flexible repayment terms than unsecured loans
Cons of a Collateral Loan
Before you consider a collateral loan, consider these risks:
- Risk of losing collateral: The biggest risk of a collateral loan is that you could lose your collateral if you can’t make your payments. In a recession, this is particularly stressful, especially if you’re putting up something like your home as collateral.
- Longer application process: Collateral loans require more paperwork and a longer application process since the lender needs to appraise your collateral and verify its value.
- Limited collateral options: You can only use assets that you own outright as collateral for a loan, which can limit your options.
- The possibility of overborrowing: Since collateral loans allow you to borrow larger amounts, it can be tempting to overborrow and end up with more debt than you can handle.
Is Factoring A Better Option Than Collateral Loans?
Both collateral loans and factoring can get you the funding you need. Factoring however is considered to be a better option for many businesses compared to collateral loans. This is because it is based on the value of a company’s accounts receivable. Your business can access funds quickly by selling its invoices to a factoring company. It can even do so without having to put up any collateral.
Factoring is also easier and faster to obtain than a collateral loan. It only requires basic financial information and you receive funding within a matter of days. You will also receive a predictable source of cash flow for businesses. This is because it is based on the value of their accounts receivable. Collateral loans on the other hand provide a lump sum of cash. Therefore, it is not necessarily tailored to the business’s ongoing needs.
Kore Capital provides factoring solutions as a more flexible and efficient option for businesses compared to collateral loans, especially for those that are looking for a reliable and predictable source of funding to support their ongoing operations.
If you explored the pros and cons of a collateral loan and decided on factoring solutions, contact our team today!