What is security for a loan?

If you are considering taking out a loan, you may encounter the term ‘security’. This is also known as collateral.

Unfortunately, the recipient of a loan is sometimes unable to pay it back. This becomes increasingly common in difficult economies. When a person or business misses a payment, this is known as ‘defaulting‘.

Image credit

Why security?

Banks and lenders will make a decision to lend partly based on their assessment of the applicant’s ability to pay the agreed amount back. This becomes especially difficult with business loans, as businesses can go through ups and downs or may be asking for a loan to fund a venture that would make them more profitable. How do banks and lenders decide whether to grant a loan?

A key tool a lender can use is ‘security’. This is a binding pledge that means a lender can recover any personal assets pledged by the loan recipient in the event that they cannot pay back the loan. This reduces the risk the lender is taking when giving a loan.

When taking out a business loan, it is also common to use something called a personal director guarantee. This is when a director, or several directors, guarantee their personal assets, such as their family home, as security for a loan for their business. Such guarantees can be risky and it is recommended that anyone asked to sign a director guarantee takes legal advice from a reputable firm such as www.parachutelaw.co.uk/director-guarantee.

Image credit

What kind of things can be used as security?

Lenders will normally ask that the value of the assets offered as security for a loan at least covers the outstanding loan amount. The list can be very varied, such as property, stocks and shares, or a vehicle or machinery.