In a secured loan, the lender has a legal claim against a borrower’s assets. If the borrower defaults, the lender can convert the assets to cash to be repaid.
The assets in a secured loan are referred to as collateral. Different types of loans are typically secured by different types of assets.
- Lines of credit are secured by accounts receivable and inventory.
- Demand loans are secured by vehicles and equipment.
- Term loans are secured by real estate.
For smaller business loans, entrepreneurs may pledge personal assets (things they own as individuals) rather than business assets.
Sometimes, the lender will have claim to a wide range of assets (called blanket charges), while other times a secured loan will claim specific assets (part of an inventory or a particular piece of equipment).
In every case, the assets are secured in addition to any promissory notes and loan agreements that may exist between the lender and borrower, and are usually registered (or “on title”) with a security registration agency. Because they are registered formally, they show up in a company’s credit history.
Interest rates on secured loans are generally more favourable than those on unsecured loans because there is greater assurance that the lender will be repaid.
More about secured loans
Within a secured loan, several types of security can be arranged:
- General security agreement—provides claims on all assets of the company (except land and buildings)
- Collateral mortgage—giving lenders claim to land and buildings
- Personal guarantee—providing lenders access to an entrepreneur’s personal assets
- Debenture—fixed and floating charges on all assets of the company, including land and buildings
In other cases, insurance—on either the assets of the company or the lives of the central owners or managers—may be made payable to lenders as part of a secured loan.