Do Banks Require Collateral When Making Loans?

Before issuing a loan, many lenders require some kind of security guarantee called collateral. Learn more about what types of loans require collateral and how it helps protect lenders.

Do Banks Require Collateral When Making Loans?

Before a lender issues you a loan, they want to know that you have the ability to repay it. That's why many of them require some kind of security. This guarantee is called a collateral, which minimizes the risk for lenders and helps ensure that the borrower meets its financial obligations. Bank loans are often the least expensive way to finance a small business.

However, it is not easy to obtain a bank loan, since banks have strict rules for granting loans. As a rule, banks will require the borrower to provide collateral for a loan. The only exception to this rule is for customers who have a long-term relationship with banks and whose business has proven profitable over a period of several years. A bank requires a guarantee to extend certain loans if the borrower's credit score does not meet the minimum requirements or if other financing risks are too high to grant an unsecured loan.

To establish the prepayment rate, the lender considers the value of the collateral over time to ensure that if the borrower defaults on the loan, the bank will recover the principal value of the loan. A loan that requires collateral may be the only type of loan a lender will offer you, especially if your credit score is low. The collateral can make a lender more comfortable extending the loan, as it protects your financial participation if the borrower ultimately fails to pay the loan in full. Banks require collateral for certain types of loans when the loan amount, the borrower's creditworthiness, and other risk factors pose too great a threat to the unsecured lender. Below is a list of the types of loans, as well as the types of guarantees that can be used to secure the loan: home mortgage loans, home equity loans, car loans, and business loans are examples of loans that require collateral.

Personal loans are generally unsecured, meaning they don't require collateral, but lenders require that some personal loans be backed by something that has monetary value. Short-term loans (with a loan term of two to four weeks) can also accept future paychecks as collateral. Alternative and online lenders can offer a variety of loans with no collateral requirements to help you meet your company's working capital needs.