There are two types of loan which a lender may grant. The first one is an “Unsecured Loans” where the lender grants the borrower an amount without any security that the loan will be paid in full.
The other type of loan is a “Secured Loan” where an asset is pledged to secure the loan in case of borrower’s default on payment. The asset placed on lien allows the lender to sell the assets to recover any loss incurred from borrower’s default. This asset placed on lien is called a “Collateral”.
Under a secured loan, there are types of collateral that can be used by a borrower as a security.
- Real Assets
Real assets are properties owned by the borrower that are often used as collateral. Most lenders prefer this type of collateral as it is high in value and often appreciates. Any real property that is subject to depreciation such as houses or buildings often depreciate slower relative to the value of the loan.
- Tangible Assets
These are physical assets excluding real property. Tangible assets are subject to depreciation and are often considered as collateral subject that the value of the asset exceeds the value of the loan. The reason for this is that tangible assets often have a short life and the value of the asset drop rapidly during the depreciation period. The dropping of value is often quicker than the current value of the loan after payments. Examples of these tangible assets that can be placed on collateral are cars, inventory and / or equipment.
- Intangible Assets
Intangible assets are assets that have no physical attribute such as cash accounts, equity portfolios and accounts receivable. This type of collateral may be advantageous for a lender as this type of asset is considered to be more liquid compared to tangible assets. There are cases where a lender would avoid equity portfolios as collateral due to the nature of its volatility.
A lender may accept a collateral to ensure that a debt is secured. The primary goal of a lender is to ensure the collectability of the money that has been granted as a loan. Having a collateral at hand minimizes the risk of incurring loss.