Asset-based lending occurs when a loan is granted primarily on the value of the assets the borrower offers as security (collateral).
For example, if a business needs $100,000 quickly but cannot easily demonstrate its ability to pay for the extra debt through cash flow (because it could be between reporting periods and does not have up-to-date financial statements), it could “pledge” a specific asset (a piece of real estate, equipment or a stock or bond) to get the loan. Pledging means agreeing to turn an asset over to the lender if repayment in cash is not possible.
The terms of an asset-based loan depend on the type of asset being pledged. Lenders prefer highly liquid assets like treasury bills, stocks, bonds, mutual funds and exchange traded funds (ETFs) because these are easy to convert to cash. Loans based on highly liquid assets tend to have higher loan-to-value (LTV) ratios, lower interest rates and more flexible repayment terms.
Asset-based loans never total 100% of the estimated value of the asset pledged. The margin is held to recover liquidation costs if necessary. This would include things like discounting the price to accelerate the sale and pay accrued interest.
More about asset-based lending
In general, the more liquid the pledged asset, the higher the loan-to-value ratio. For example: A lender may grant up to 90% of the face value of a highly marketable security, 75% for residential real estate or 60% for commercial real estate.