How Collateral Security Strengthens Loan Approval and Reduces Risk

What is Collateral Security?

Any valuable asset other than the primary secured, offered by the borrower to the lender, is termed collateral security. The ownership of the secured asset remains with the borrower until the repayment is fulfilled. The lender may also have the right to sell the security to retain the amount due, depending on the security arrangement, terms and conditions. In case of failure of loan repayment, the lender can seize the asset.

Examples of collateral securities are: gold or jewellery, vehicles, business assets, property, and mutual funds in certain lending arrangements.

Types of Collateral Security

Collateral securities could be of many types:

1. Real Estate

   Real estate is a common security for loans and mortgage financing. These include properties such as houses, land, or commercial buildings.

2. Cash Collateral

   Cash collateral is a low-risk security for lenders because of its high liquidity. It includes bank balances, cash deposits, or fixed deposits.

3. Marketable Securities

   These are investment products that can be quickly sold in the market. Examples include equity shares, mutual funds, government securities, bonds, and debentures.

4. Vehicles and Equipment

   Vehicles and equipment are kept as security for equipment financing and auto loans. They are cars, machinery, or equipment.

5. Inventory

   This is common for business financing. It refers to goods or raw materials owned by a business that are pledged for securing a working capital loan.

6. Gold and Jewellery

   Many people often keep their gold and silver items as collateral for gold loans.

Why Consider Collateral Security?

Collateral security helps lenders in many ways, including:

• High Loan Amount: When the value of the primary security does not match the loan size, collateral security helps increase the loan amount.
  
  
• Weak Credit History: Often, borrowers with weak or inconsistent credit history are required to provide collateral security.
  
  
• Unstable Cash Flow: Lenders demand collateral security for seasonal or cyclical businesses.
  
  
• Industry risks: Collateral securities might be needed when firms work in unstable sectors.

Key Takeaways

Collateral security is pledged security against a loan, giving the lender a claim if the borrower defaults. It helps in raising a loan with the flexibility to retain the asset. The lender feels secure while giving a loan with collateral security, and often gives low interest rates as well.