Taking out a small business loan gives you access to funds you can use as working capital, expand your operations, or purchase a new piece of expensive equipment. But for lenders to take the risk of loaning to you, they’ll probably need something to protect themselves from loss in case you default. That’s where collateral and personal guarantee come in.
If you’re considering a Small Business Administration loan, you’re probably wondering if it requires any form of collateral or guarantee. Keep reading to learn what collateral and personal guarantee are and whether you need them when applying for an SBA loan.
What is Collateral?
Collateral is an asset you pledge as a borrower to the lender to serve as security for the loan. Most lenders require a form of collateral to lower their lending risk. If you default on your loan payments, the lender will seize the asset and sell it to recoup the remaining loan balance.
Collateral can take many forms, and it may vary depending on the nature of the loan. For example, your home becomes collateral when you take out a mortgage. The most popular forms of collateral include cars, investment accounts, savings accounts, and business assets like inventory, equipment, and outstanding invoices.
What is a Personal Guarantee?
A personal guarantee is a legal obligation that authorizes the lender to use your personal assets to repay the loan if the business can’t repay the loan. For example, if you sign a personal guarantee when taking out a small business loan, the lender can seize your personal property like your house, car, savings accounts, or retirement fund to cover the losses.
There are two common types of personal guarantees: limited and unlimited personal guarantees. The one you’ll sign chiefly depends on the type of loan you’re looking to get, the kind of business you operate, and the lender. Understanding the differences will help you determine which one works for you.
Unlimited Personal Guarantee
Also referred to as an unconditional guarantee, the unlimited personal guarantee means one personal guarantor is responsible for paying back the loan amount in full if the business cannot. In addition, the lender can seize liquid assets like savings accounts and physical assets like real estate to recoup the defaulted loan.
Limited Personal Guarantee
This type of guarantee is used when multiple business partners are signing the guarantee. Each owner is liable for up to a specific percentage if the loan goes into default. If you own less than 20% of a business, you may be required to sign a personal guarantee.
SBA Loan Collateral vs. Guarantee
SBA loans are the most sought-after loan types for small business owners. But the most asked question is, do SBA loans require a personal guarantee?
Do SBA Loans Need a Guarantee?
The SBA generally guarantees small business loans, meaning if your business cannot repay the loan, the government agency guarantees a portion of the loan to the lender. Since the SBA guarantee means less risk to the lender, they’re more likely to lend to businesses they wouldn’t otherwise work with. As a result, SBA loans are the most highly-regarded small business loans because of their typically higher loan amounts, longer repayment terms, and lower interest rates.
If you’re looking to get an SBA loan, you might be wondering, do SBA loans need a guarantee? The short answer is yes. SBA loans need a personal guarantee for business owners with 20% or more ownership. When you sign a personal guarantee as part of the loan agreement, you permit the lender to seize your assets to repay the remaining balance.
Who Needs to Personally Guarantee an SBA Loan?
In accordance with the SBA regulations, every loan should be guaranteed by at least one person. If no individual owns 20% or more of a business, at the minimum, one owner must give a complete unconditional guarantee. Those who own more than 20% should provide an unlimited full guarantee.
While the SBA needs one personal guarantee, lenders have the freedom to ask for an unlimited or limited personal guarantee from business owners with less than 20% ownership. For example, a lender may need a personal guarantee if the primary business owner has less-than-stellar credit.
Do You Need Collateral for an SBA Loan?
Most SBA loans require collateral to back up the borrowed amount. However, the collateral size will vary depending on the size of the loan. For example, SBA 7(a) loans between $25,000 and $350,000 must follow collateral policies similar to that of non-SBA loans.
If you take out an SBA loan to cover the cost of equipment purchase, the equipment itself serves as collateral. You also have the option to use other forms of assets as collateral, and some lenders accept personal assets too.
For SBA 7(a) loans larger than $350,000, SBA lenders require full collateral of the loan amount. For instance, if your loan is $450,000, you’ll need collateral worth the borrowed amount. If the assets do not completely back up the loan, the lender may include trading assets.
What Form of Collateral is Required?
The form of collateral needed varies depending on the SBA lending partner and the loan amount you’re looking to borrow. Here are some of the most common forms of collateral required by SBA lenders:
- Personal Residences: You can pledge your home as collateral to secure an SBA loan. While this is often a risky venture, use your personal residence as collateral if you’re sure you won’t default.
- Retirement Accounts: Your 401(k), IRA, Roth IRA, and other retirement accounts can help you get a loan from the SBA. Not all retirement accounts allow you to borrow against, though. Only qualified 401(k), 403(b), and defined benefit pension plans do.
- Commercial Real Estate: If you have a commercial property, you can use it as collateral to get an SBA loan. Lenders will want to confirm if the property is yours, so prepare the necessary documentation.
- Equipment: Business equipment is a low-risk type of collateral than using your home or car to secure a loan. If you own machinery, computers, and other equipment that retains value, they can help you secure a loan.
- Commercial Vehicles: While personal cars are most known to serve as collateral for a loan, you can also use commercial vehicles.
- Accounts Receivable: This is the money a company’s customers owe for goods and services received but not paid. You can pledge accounts receivable as collateral to secure a short-term loan or line of credit.
- Inventory: Product-based businesses can use their inventory to secure financing. Usually, the inventory acts as the collateral for the loan.
