Pledging personal assets as collateral is a common requirement for many franchise loans, especially loans that come from a bank traditional bank. Personal collateral could be anything from a home or investment portfolio to a car or piece of equipment that you own personally. Lenders seek personal collateral as security on a loan to minimizes their risk. When you pledge collateral, you are saying that if you default on the loan, you will give the lender the collateral you have pledged. It’s like saying ,”I’d bet the house on the fact that I will repay this business loan”, and then actually betting the house on it. This isn’t necessarily the best idea because a business could default on a loan for any number of reasons, and not all of them are within the control of the owner. If any unforeseen circumstances arise and the business can’t repay it’s debt, the lender can seek to claim any and all collateral that has been pledged.
Now, the only benefit in pledging personal collateral is that it will help business owners with less-than-perfect credit acquire financing if they couldn’t otherwise do so. But again, doing so puts you in danger of losing those assets if you default on your loan
Alternative lenders typically do not enforce rules regarding loan collateral in the same way that banks do, which gives business owners a good way to get around using personal collateral. Instead, alternative lenders will usually require some form of guarantee.
You may be thinking, “well I never default on my loans so why does it matter if I use personal assets for collateral.” This is when it is important to know about the hidden costs of using personal assets for business ventures. When you pledge personal assets for a business loan, you are essentially tying up that assets ownership until you pay off that entire loan. For example, if you use your house as collateral for a massive business loan, you may save 1% on your interest rate. However, what happens if you decide to sell your home and upgrade to a bigger, newer home? There will now be a secondary lien on your home which will follow you to your new home. Since it’s impossible for a bank to just take half of a house if you were to default, they place a blanket lien on your home and will collateralize it, even if it’s twice as big and twice as expensive as the home you originally pledged. Or, if you were to sell your home and make some profit on the sale, you may have to pay down some of the loan in proportion to how much profit you have made.
Another hidden cost of pledging personal assets as collateral for a business loan comes when you pledge cash or securities as collateral. If you plan on expanding in the relatively near future, you could run into some trouble because any pledged cash or security cannot be used for a down payment until the loan that they are collateralized towards is paid off. Pledging cash and securities is a smart way to say look, I have the money here to pay the loan if I need to but I would like to finance this purchase so I don’t bleed through my liquid assets in one fell swoop. This can hurt your future plans if you planned to use that money for a down payment for an even bigger loan to expand your business.
Every business is different and it may be smart to use personal collateral for some business purchases. However, we recommend using personal collateral as a last resort and keeping your business and personal lives separate when it comes to financing. At Harbour Capital, we offer low rates without requiring personal collateral for most of our business loans. Give us a call today or apply below to see how we can help your business grow!