The 5 Cs of Credit: Collateral

We have been discussing how lenders and the SBA use the Five Cs of Credit when assessing a 504 loan application: Character, Capacity, Capital, Collateral and Conditions. The quality of Collateral refers to the asset or assets a borrower pledges to secure a loan.

In addition to having character, capacity, and capital, lenders usually require borrowers to pledge assets as security for the loan. While cash flow is the primary source of loan repayment, collateral provides the lender a secondary source of repayment if the cash flow is unavailable or interrupted.

Collateral serves as the lender's protection against a borrower failing to make payments on the loan. If a borrower defaults on a loan, the lender then becomes the owner of the collateral. Therefore, lenders prefer assets that retain their value regardless of business conditions, such as land or buildings.

Lenders will also consider as collateral assets that are usable in the business, such as equipment, furnishings, and inventory, but only if they can be sold for cash. If the value of the business's assets is not sufficient, lenders could require personal assets as collateral, such as life insurance policies. Lenders will see your willingness to pledge personal assets as a sign of your commitment to your business. The loan agreement should specifically identify any item used as collateral.

When lenders examine collateral offered by borrowers, they prefer assets that are easily liquidated for cash. Lenders do not want to take ownership of your assets, and they are not interested in operating your business. Even if you have plenty of assets to offer, lenders will also consider the length of time required to liquidate those assets. Lenders always prefer a healthy cash flow to any collateral that is hard to sell.

Community Business Finance's 504 Loan Program is used to finance land, buildings or heavy equipment. These assets will be used as collateral on the loan, and in some cases other collateral is required. We will help you identify your collateral assets and gather the information needed for the 504 loan application.

We will be concluding our examination of the 5 Cs of Credit next week. Understanding the 5 Cs lets you better evaluate your business and produce a successful loan application.

Contact Community Business Finance and discover how our knowledge of SBA 504 loans can get your business the financing it needs.

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