Real Estate as Collateral for Asset-Based Business Loans
Small business owners that have equity in their home or commercial land or building and want to leverage that equity to secure finance for their business may find that using both personal and commercial real estate as the foundation for obtaining a business loan is intriguing. With the number of commercial buildings on the rise, a business owner may be able to get a line of credit by leveraging that real estate with a second or third lien. There are around 5,600,000 commercial buildings in the United States in 2021, an increase of roughly 14% over the previous decade. With the rise in commercial buildings (many of which are owned by small businesses who use the space as owner-user properties), a business owner can now use the building’s or land’s net worth to secure financing that would otherwise be unavailable from traditional lenders.
What is Asset-Based Lending, and how does it work?
The process of providing business financing based on monetizing the company’s balance sheet is known as asset based lending (ABL). A company’s assets, such as receivables, real estate, inventory, equipment, and machinery can be used as collateral to secure funding. A line of credit is the most frequent asset-based financing facility, while asset-based term loans are also widespread. Other types of asset-based lending include merchant cash advances, factoring, equipment leasing, and invoice financing, in addition to lines of credit and term loans. The asset-based lender will establish a lien (UCC-1) on the asset after providing funding to the company.
What is the definition of collateral?
Collateral is an asset that can be used to secure a small business loan from any lender. The lender will place a UCC-1 lien on the business or personal asset when they offer funding to the small business, and if the borrower fails to repay the loan, the lender can seize the collateral to assist recoup their losses. The lender’s risk exposure will be reduced, which will be reflected in the rates offered to the borrower. Secured business loans with collateral provide lower interest rates than unsecured business loans.
What type of property can be used as collateral?
Asset-based financing can be secured with almost any commercial property. When a business seeks for a term loan, traditional lenders may place a lien on commercial real estate, but they rarely utilize personal real estate to secure funding (although they may require a small business owner to sign a personal guarantee). They are possibly guaranteeing all of their own assets, including their own personal real estate, if they sign the personal guarantee). Asset-based lenders, on the other hand, will try to secure loans using the personal home, property, and/or land of the business owner. Lenders willing to make asset-based loans utilizing real estate recognize that the borrower is likely to have a mortgage on their property, thus they are willing to take second positions subordinate to the mortgage lender while still providing financing for up to 65% loan-to-value.
What Types of Financing Are Available When Real Estate Is Used as Collateral?
Businesses that want to unlock the equity in their real estate can choose from a variety of financing solutions. There are funding options organized as a term loan, a line of credit, or ACH financing available from big banks to subprime asset based lenders. For a term loan, most traditional bank business lenders will look to use commercial real estate alone as collateral. Alternative asset-based lenders will try to extend lines of credit based on the collateral and the cash flow of the business. Subprime asset-based lenders will typically structure the loan similarly to a merchant cash advance, requiring daily or weekly ACH repayments from the company’s bank accounts. Rates are higher than traditional finance, but because the loan is secured by real estate, asset-based loans with real estate offer lower rates than high-interest cash advances.
What are the Fees and Conditions?
The type and quality of collateral used to secure an asset-based loan determines the rate and terms of the loan. Loan-to-value rates for accounts receivables are typically around 80%, whereas inventory and equipment are often around 50%. Even in the second and third slots, asset-based loans involving real estate might have up to a 65% LTV. Rates vary a lot as well. Traditional asset-based lenders have interest rates in the single digits, however subprime asset-based finance companies can have interest rates as high as 20%. Term lengths can range from one to five years, with one to three years being the most common.
What is the Procedure for Obtaining an Asset-Backed Loan?
Depending on the lender, the process for obtaining an asset-based loan differs. If you’re searching for traditional asset-based financing, you’ll need to give the following information:
- 3 years tax returns
- Income Statements for the Past Three Years (including year-to-date)
- balance sheets over the previous three years (including year-to-date)
- A/R and A/P aging schedules
- Schedule of liabilities
- Collateral appraisals
You will need to give the following information if you are searching for subprime asset-based loans using commercial real estate or personal land, real estate, or other property:
- Application for a loan
- Statements of account
- BPO collateral and title report
The due diligence and underwriting procedure might take anywhere from 1-4 weeks once all paperwork has been submitted to the lenders.
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