What is Collateral, Types of Collateral, and uses of collateral

1. COLLATERAL

2. Definition
Collateral – is money or property that is pledged
as security for repayment of a loan.
This is often required by lending institutions as a
safeguard in case the loan is not or cannot be
repaid. As a result, the collateral used can now
be sold by the lending agency.

3. PURPOSE
 If a loan is not repaid on time the assets used
as collateral can be seized or sold to recover
the balance of the loan.
 Collateral makes an investment more
attractive and interesting to investors.
 Adding collateral minimizes the risk of an
investment’s default, i.e., the foregoing of that
item to repay debt since most companies or
individuals do not want to lose their pledged
collateral as a result of non payment.

4. Collateral is important because it is
often used to access the capital or
money needed to start a business.
This is so as entrepreneurs do not
have the necessary money to finance
start up operations of their business.
VALUE of Collateral

5. TYPES of Collateral
 There are infinite types of collateral in
existence as virtually anything can be used
for such purposes as long as it is
acceptable to the lender.
 The nature of the collateral acceptable for
any loan would depend upon the type of
loan, structure of repayment terms and
conditions, amount borrowed.

6. Types cont’d….
The following are some of the
common types of collateral usually
demanded and accepted by
commercial loan lenders.

7. Types cont’d
1.Real Estate – land and building represent one
of the most common types of collateral in use
especially for long term loans. These can be
houses, office buildings, shopping centers,
warehouses or factory buildings.
Using the home of the entrepreneur as a form
of collateral is very risky since the bank will
have the legal deed to the house and if the
business fails, it has the right to sell and
recover the loan payment.

8. Not only is the entrepreneur’s livelihood
affected but also the security of his family is
at stake.
The business premises can only be used if the
business owns the building and it is not being
paid for by an existing loan or mortgage.

9. Types cont’d
2. Plant and Equipment – This refers to
manufacturing plant & machinery, trucks,
drilling rigs, presses, forklifts and similar items.
These are usually applicable to long term
loans.
In order for the lender to ascertain the
appropriate amount to be sanctioned for the
loan, a professional valuation is obtained of
the plant and machinery to be used as
collateral.

10. Equipment trust certificates are then issued as
bonds secured by as specific type equipment.
3. GUARANTOR - this is another person with
adequate personal wealth who agrees to pay
the back the loan back if the business should
fail and it defaults on the loan repayments.
The bank will ask for details of the guarantor’s
assets before agreeing to this form of
collateral.

11. Types cont’d
4. Life Insurance Policies - this pays out a pre-
determined amount of money on the death of
the policy holder.
Banks often insist on these as collateral
because in the event of the entrepreneurs
death, it would be unlikely that the business
itself could repay outstanding loans.

12. Types cont’d
5. Life Assurance Policies - these are forms of
savings the entrepreneur many have arranged
with an insurance company. They pay out a
certain sum either on death or after a stated
number of years.
If they had a definite ‘surrender” value then
banks would be prepared to accept these as
security on the loan.

13. Types cont’d
6. Personal Guarantee – this applies to limited
companies only as with other business types
the owner’s assets are already at risk from
business failure.
Here, the directors of the company promise to
pay up from their personal funds should the
business be unable to make loan repayments.

14. Types cont’d
Other items can be used as collateral,
including:
 Investment documents (such as share
certificates and debenture certificates)
 Antique furniture
 Gold, silver and other valuable jewellery
 Rare and valuable works of art
 Appliances