What are the Different Types of Collateral?

M.J. Casey
M.J. Casey
Man climbing a rope
Man climbing a rope

Applicants for credit are often required to provide collateral for the loan; a property in which the applicant has an interest may be assigned to the creditor should the borrower fail to make payments. The collateral may be greater, less than, or equal in value to the proposed loan amount, depending on the creditworthiness of the borrower and the liquidity of the property. Anything of value may be used as collateral as long as both parties to the loan or note can agree on its value. Tangible and intangible properties may be considered.

Tangible properties are those that can be sensed, counted, and valued easily. Common types of tangible properties used as collateral are real estate, fixtures, inventory, and equipment for businesses. For individuals, tangible property includes real estate, jewelry and art, and cash equivalents such as stocks, annuities, and life insurance cash value.

Intangible products may or may not be easy to establish value for. Payment rights in accounts, chattel paper, financial instruments, and legal judgments may be complicated by changes in the marketplace, legal decisions, or an inability to liquidate the supposed asset. Payment rights are the rights to future payments for any reason, such as lottery winnings, residual earnings, or rights to payments of past invoices when collected by new owners of a business. Chattel paper represents the documents that convey an interest in goods, either owned or leased. Financial instruments often refer to investment funding of some type, such as money markets, insurance trusts, or bundled assets.

Legal judgments are funds awarded by a court of law. Anticipation of claims made for personal injury, medical malpractice, or violations of law are seldom acceptable forms of collateral. Collecting on these claims is often very difficult for corporations and individuals alike.

Other intangible products are those that may have substantial value in the future but are currently of little worth. Loans that offer this type of collateral often take the form of partial ownership of a new enterprise rather than a note. Examples are software development, patents and inventions, and new business or marketing concepts. These properties are associated with high risk- high return ventures.

Potential borrowers, when considering what collateral to offer to satisfy a loan requirement, need to keep in mind that creditors do not usually want the property. Instead, they want to be repaid. Thus, the emphasis of the application should be on the ability to generate sufficient cash flow to meet the loan obligation without needing to proceed to the costly and difficult steps to acquire and liquidate the collateral.

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