Collateral

Collateral

You might need a loan if you’re a small business owner to finance your enterprise. A business loan is difficult to obtain. Secured loans and unsecured loans are the two types of loans that financial organisations give. The key distinction between the two is the collateral requirement for fast loans. 

An asset known as collateral lowers the risk for a lender by shielding him from potential borrower default. Lenders can recover losses by selling the collateral. 

What is collateral? 

Assets pledged by a borrower to a lender (or creditor) as security for a loan are known as collateral. 

Generally speaking, loans with collateral have lower interest rates than loans without. The lender’s risk of default is decreased when business loans are secured. The borrower is also more inclined to repay the loan if they know they could lose their collateral. 

Borrowers generally look for credit on factors like commercial real estate, residential or transportation equipment, manufacturing supplies, or even intangibles (like intellectual property) for businesses. If a loan exposure is supported by collateral, it is referred to as a secured credit; otherwise, it is referred to as an unsecured exposure. 

Understanding collateral 

The interest rates on loans with collateral are typically substantially lower than those on unsecured loans. A lien is a legitimate claim by a lender against a borrower’s property to settle a debt. The borrower has a strong incentive to repay the loan because he risks losing his home or other assets used as collateral if he does not. 

The lender may seize collateral—a valuable item—from the borrower if he fails to repay a loan according to the terms stipulated in the agreement. One such example is when you take out a mortgage. The bank will typically require your home as collateral.  

This implies that the bank has the authority to seize your property if you are unable to meet the conditions of your mortgage repayment. Collateral guarantees that the lenders will still receive their money even if the borrower defaults on the loan, allowing the bank to sell your home in order to collect the loaned money. 

How collateral works 

The financial organisation assesses your ability to repay the loan before approving it. It needs some sort of security, which lowers its danger. The lender may seize and sell the deposit if you’re unable to make your loan payment. The potential loss of your asset  ensures that you make your loan repayments on time, and the collateral depends on the loan’s terms. 

For instance, the collateral for a home loan would be the house itself. Similarly, the car serves as security when you obtain a vehicle loan. A variety of assets can also back other forms of borrowing. 

Types of collateral 

Collateral

Consumer commodities, equipment, farm products, inventories, and property on paper are the five basic categories of collateral. 

  • Customer goods, such as cars, are items that the average consumer buys. 
  • Items primarily employed in commercial or governmental operations are considered equipment. 
  • Crops and cattle are examples of farm products. 
  • Work in progress or raw materials makes up inventory. 
  • Stocks, bonds, and even money kept in a savings or checking account are property stored on paper. 

Examples of collateral 

The following are typical collateral examples: 

  • Mortgages for homes 

A loan with a mortgage uses the home as collateral. The loan servicer may begin legal action if the homeowner misses at least 120 days of mortgage payments. By completing these steps, the lender may eventually be able to foreclose on the property and seize control. Once the property has been transferred to the lender, the remaining principal on loan may be repaid by selling the property. 

  • Loans for a home equity 

A house may also be collateral for a second mortgage or home equity line of credit. The amount of the loan in this situation won’t be greater than the equity that is accessible. For instance, if a home is worth 200,000 US$ and the original mortgage has a balance of 125,000 US$, only 75,000 US$ will be accessible for a second mortgage. 

Frequently Asked Questions

Each Family Member of a Requesting Party, SNH, RMR LLC, and any other Person who Constructively Owns Common Shares as a result of attribution under the Code from one or more of the Requesting Parties (or their estates or spouses), SNH, or RMR LLC are all considered “Collateral Persons” (other than SNH and the Requesting Parties, and, upon the death of any Requesting Party who is an individual, their estates and spouses). 

Cash and Non-Cash Collateral Management, Swap Agent Operations, Collateral Client Services, Reconciliations, and Change Management make up the Collateral Operations team. 

Three factors—the desire to reduce counterparty risk, the ability to enable more favourable pricing of credit risk, and improved market access— contribute to the growing significance of collateral management. 

A valuable item is pledged as security for a loan. Collateral reduces the risk to lenders. If a borrower defaults on the loan, the lender has the right to sell the collateral to recoup losses. 

Collateral can reduce risk to lenders by providing them with an asset they can seize if the borrower defaults on the loan. This can provide security for the lender and help them recoup their losses if the loan goes bad.  

However, it is important to note that collateral is not a fool-proof way to reduce risk, as there is always the possibility that the collateral itself may not be worth enough to cover the loan. In addition, even if the collateral is valuable, the borrower may still default on the loan, in which case the lender would still suffer a loss. 

Four qualities of high-quality collateral are: 

  • Being easily quantifiable and having a value adequate to pay off the loans it is securing. 
  • Holding its worth for the whole loan term. 
  • Being easily susceptible to foreclosure or having its ownership changed. 
  • Being in a liquid state. 

Related Terms

    Read the Latest Market Journal

    Weekly Updates 4/3/24 – 8/3/24

    Published on Mar 4, 2024

    This weekly update is designed to help you stay informed and relate economic and company...

    Weekly Updates 26/2/24 – 1/3/24

    Published on Feb 28, 2024 60 

    This weekly update is designed to help you stay informed and relate economic and company...

    All-in-One Guide to Investing in China via ETFs

    Published on Feb 27, 2024 352 

    Start trading on POEMS! Open a free account here! Why China? In the vast landscape...

    Navigating the Post-Inflation Landscape in 2024: Top 10 US Markets Key Events to Look out for

    Published on Feb 23, 2024 368 

    Start trading on POEMS! Open a free account here! In 2023, the United States experienced...

    From Boom to Bust: Lessons from the Barings Bank Collapse

    Published on Feb 23, 2024 61 

    Barings Bank was one of the oldest merchant banks in England with a long history...

    Decoding FX CFD 2.0

    Published on Feb 20, 2024 66 

    This article is aimed at availing information and knowledge essential to intermediate forex traders. It...

    Weekly Updates 19/2/24 – 23/2/24

    Published on Feb 19, 2024 89 

    This weekly update is designed to help you stay informed and relate economic and company...

    Unlock Prosperity with 5 Sure-Fire Financial Instruments!

    Published on Feb 14, 2024 198 

    In Singapore, the concept of guaranteed returns may evoke the spirit of prosperity, reminiscent perhaps...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com