Acceptable Collateral for Bank Loans – Obtaining a loan from a bank or an individual requires collaterals and one may ask What is acceptable collateral, Do commercial banks or lenders accept anything as collateral? If you are one of those seeking answers to these questions, then we have a detailed explanation that would meet your needs.
- Meaning and concept of collateral
- Acceptable collateral for bank loan
- Alternatives for Collateral
- Unacceptable Collaterals for loan
- Importance of Collateral in Loan Approval
Meaning of Collateral:
A collateral is any valuable offered to the bank in exchange for funds (Loan). It is not just any valuable but something that’s worth a great deal. It is a way to lessen the risk of borrowers in their transactions with the lenders. Before any bank accepts what borrowers offer as collateral, they conduct certain background checks to authenticate.
If the borrower defaults in payment, the lender uses the collateral as a source of retrieval of funds and this action is considered lawful. So for the inquiries on whether banks accept anything as collateral, we say No.
Acceptable Collateral for Bank Loans
Below are a few examples of the typical forms of suitable security for bank loans in Nigeria:
Real estate such as land, acreage, residential or commercial property is one of the most preferred types of collateral by banks in Nigeria. Banks feel more secure issuing loans when solid real estate is pledged as it maintains or even appreciates in value over time. For larger loans, banks may require collateral in the form of a legal mortgage over the real estate which gives them the right to foreclose and sell the property to recover funds if the borrower defaults. The property offered as collateral should have a proper title document and up-to-date paperwork to satisfy the bank’s requirements.
Securities like stocks, bonds, and mutual funds that are actively traded on stock exchanges are valid collateral for bank loans in Nigeria. The acceptability depends on criteria like market price, trading volume, volatility, dividend yield, and rating. Banks will place a suitable margin on the current market value of the securities to account for fluctuations in prices before sanctioning the loan amount. The collateral value needs to be maintained during the loan tenure.
Fixed Deposits Fixed or time deposits held with the lending bank are also readily accepted as collateral for loans in Nigeria. Borrowers can pledge their existing fixed deposits or create new ones using the loan amount. Banks favor fixed deposits as collateral because it allows them to easily recover the loan by prematurely breaking the deposit in case of default. The amount of the fixed deposit required is usually at least equal to the loan amount. The tenure should also adequately cover the loan tenure.
For loans to companies, banks may accept inventory and accounts receivables as collateral. This is more common for working capital loans to meet short-term needs. Banks will evaluate the quality of inventory and the credibility of accounts receivable before accepting them as collateral. Proper documentation of inventory value through stock audits and debtor confirmations need to be submitted. Banks also use margins and haircuts to discount inventory/debtor values to factor in risks.
Gold is a traditional form of collateral that retains its intrinsic value over time. Banks accept gold jewelry, bars, and coins as collateral but only after checking for purity through hallmarking and quality certificates. The gold needs to be stored in the bank’s locker or insured vaults during the loan period. The collateral value is determined based on current gold prices minus a suitable margin.
Banks may also accept heavy equipment, machinery, vehicles, etc. as collateral for loans. This is common for asset financing loans taken to purchase the equipment itself. The equipment has to be adequately insured and maintained by the borrower during the loan tenure. The collateral value depends on factors like the type, condition, age, resale value etc. after applying appropriate depreciation. Banks will also file a charge on the collateral assets.
Securities issued by the Nigerian government such as treasury bills and government bonds are liquid assets that are readily accepted by banks as collateral. The advantage is that such securities usually do not fluctuate too much in value and have negligible risk of default. They can be easily liquidated by banks to recover loan amounts in case of borrower default.
For small business loans or loans to startups that may not have substantial assets to pledge, banks may accept a personal guarantee from promoters or directors as collateral security. This makes the promoters/directors jointly liable for loan repayment. Banks can then recover dues by pursuing personal assets and accounts of the guarantors in case of business loan default.
Alternatives to Collateral
While the use of collateral is almost indispensable in obtaining a bank loan, however, provisions has been made for alternatives. Here, we explore the different alternatives to collaterals.
- Cosigners or Guarantors
- Cash Collaterals
- Accounts Receivable
Borrowers who do have much valuable could present influential people as cosigners who would act as their guarantor. A certain amount of money may also be deposited with the lender to serve as the cash collateral. Acceptable Collaterals for Bank Loans
Account receivable also guarantee the borrowers and help reduce their risk of loss. In this case, a debtor to the intended borrower is involved. Account receivable are funds due to a company but not yet remitted. It is basically money for goods and or services rendered but not yet paid for by the client. These three may be used as alternatives to collateral by financial institutions who honor them.
Unacceptable Collaterals for loan and Reasons they are not Accepted.
Here, there is a side by side measure of the unacceptable collaterals for loan with the acceptable collaterals. If you present some of the underlisted, they may not accepted. This may be due to their inferior market value, or high possibilities of its depreciation. they include :
- Non-Transferable Assets: This include items without logical values, items handed down from one generation to the other and which is expected to continue. These cannot be accepted because of the difficulties involved in its liquidation process.
- Risky Investments: Investments involving risk and uncertainties such as cryptocurrencies and the likes. They are not accepted because their value is unpredictable and uncertain.
- Intangible Assets: These include intellectual properties like personally owned or written books, copyrights, or patents. They are not accepted because it is difficult to ascertain their accurate value, as it may be lesser in value than it was proposed to have been.
Controversial items be it landed properties, cars, jewels etc. will not be accepted once it is confirmed to be of controversial status.Acceptable Collaterals for Bank Loans
Importance of Collateral in Loan Approval
Collateral can increase one’s chances of loan approval. In other words, with a good collateral, good credit history and proof of credit worthiness, one’s loan application may be approved without hassle. Collaterals are not outright gift to the bank, rather, it is something to hold on to just to mitigate risk of financial loss. At the expiration of the contract, the lender maintains full right and possession to his or her property.
In summary, real estate, fixed deposits, securities, inventory, gold, and equipment are the most common and readily accepted types of collateral for bank loans. Banks will evaluate the quality, value and risk before accepting any asset as collateral. The collateral value is carefully assessed after applying suitable margins and haircuts. Proper documentation and insurance of the collateral assets is also mandatory for the entire loan period. The choice of acceptable collateral also depends on the type of loan, its tenure and the profile of the borrower.