Everything You Need to Know About How an Asset Based Loan Works

When a lender decides to make a loan, he or she needs to have some confidence that the money will be repaid. In some cases, this means securing the loan with an asset. Mortgages, auto loans and factoring loans are all examples of loans secured by assets. What should you know about this type of financing before working with a lender?

You Lose the Asset If the Loan Isn’t Repaid 

The most important thing to know about asset-based lending is that you will lose your collateral if the loan isn’t repaid. Typically, collateral is a home, car or shares in a brokerage account. Therefore, your financial security both now and in the long run could be compromised because of a missed payment. Sometimes, a lender will work out an alternate payment plan if you are worried about making your next payment.

Collateral Can Reduce Your Interest Rate

Providing a lender with collateral reduces the risk that the lender won’t be repaid. Therefore, you will likely get a lower interest rate to reflect that fact. For a business, a secured loan may be worth taking on because the money saved on interest payments can be used for other purposes. Paying less in interest may also allow a company to pay down the principal balance in a shorter period of time.

What Types of Assets Can Be Used as Collateral? 

Anything that a lender perceives to have value can be used as collateral. Companies routinely use their accounts receivable as the basis for a loan or advance. Businesses can also use inventory, land or equipment to secure a short or long-term loan. Individuals can use a coin collection, artwork or other personal property to secure either personal or business loans.

What If the Collateral Is Worth Less Than the Loan Balance? 

It is possible that the loan balance will be more than what the collateral is worth. In this scenario, the lender could come after you for the outstanding balance. However, whether this actually happens or not depends primarily on your ability to pay and the amount owed. If a lender determines that it loses more by pursuing a remaining balance, it will likely decide to simply write it off.

While secured lending can have its advantages, it is important to never borrow more than you need or can afford to repay. This is the best way to ensure that you don’t lose assets or damage your credit rating. It is also a good way to avoid the emotional toll that not being able to repay a loan can take on you.