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COLLATERAL

Collateral refers to assets pledged as security for loan repayment, allowing lenders to recover funds if the borrower defaults. It can include various types such as real estate, equipment, natural reserves, and personal guarantees, depending on the loan terms. The use of collateral minimizes investment risk and is crucial for entrepreneurs seeking capital to start their businesses.

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Soraiya Mohammed
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12 views22 pages

COLLATERAL

Collateral refers to assets pledged as security for loan repayment, allowing lenders to recover funds if the borrower defaults. It can include various types such as real estate, equipment, natural reserves, and personal guarantees, depending on the loan terms. The use of collateral minimizes investment risk and is crucial for entrepreneurs seeking capital to start their businesses.

Uploaded by

Soraiya Mohammed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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COLLATERAL

Definition
This refers to the standing value
of an item which can be kept as
assurance that money will be
repaid to the lender or lending
institution. It is therefore any
asset that secures a loan or debt
and plays a role in how valuable
and desirable that asset may be.
Definition cont’d
 Collateral can also be defined as
money or property pledged as security
or guarantee for the 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.
PURPOSE

 Ifa 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
Purpose con’t…..

 Adding collateral minimizes the risk


of an investment’s default, ie, 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.
VALUE of Collateral

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.
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.
Types con’t….

The following are some of the


common types of collateral
usually demanded and
accepted by commercial loan
lenders.
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. 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.
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.
Types cont’d
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. Equipment trust
certificates are then issued as bonds
secured by as specific type
equipment.
Types cont’d

3.Natural Reserves – Oil and


Gas reserves as estimated by
qualified engineering firms
can be used as collateral for
loans especially long term
loans and project tied loans.
Types cont’d
4. Portfolio of Securities – this
refers to a collection of
investments that could include
stock of other companies,
bonds, treasury notes. One
type of investment that uses
securities as collateral is a
repurchase agreement.
Types cont’d
In this agreement, one party who is
the buyer is lending money and
receiving securities as collateral. The
other party who is the seller is
borrowing money and giving the
securities as collateral for the loan.
The seller commits to buying the
securities back from the temporary
buyer at an agreed upon price
including interest at a specific future
date.
Types cont’d

If the seller defaults on the agreement


to buy back the securities, the buyer
can sell the securities on the
secondary market.
Types cont’d

5. Revenue municipal bonds – when a


government wishes to finance projects
such as the building of roads or bridges it
issues these bonds as pledged collateral to
cover revenue of the project it finances.
However revenue bonds only pay back the
bonds principal and interest if enough
revenue is produced by the financed
project.
Types cont’d
6. 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.
Types cont’d

7. 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.
Types cont’d

8.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.
Types cont’d

9. 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.

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