When you are applying for a business loan for equipment or premises, a financial institution will often ask for security.
Security gives the lender some protection in case you are unable to repay the loan. Real estate is the most common type of security taken but business assets and cash (term deposits) are also used.
Lenders won’t automatically provide you with a loan just because security is available. They need to be convinced that you can repay the loan too.
Secured loans are easier to obtain than unsecured loans and are generally charged a lower interest rate. That’s because lenders are required by their regulators to allocate a portion of their capital (their equity) for each loan made. Generally they are required to allocate less capital for secured loans than for unsecured loans, and less where residential property is the security compared to commercial property.
Lenders have a Loan to Valuation Ratio (LVR) to which they generally can lend and still classify the loan as secured. This maximum LVR (expressed as a percentage of the market value of the property) varies between different types of properties and between lenders. If the LVR for residential properties is above 80 per cent (sometimes less for units, inner city apartments, and luxury properties) and above 70 per cent for commercial properties, the lender may be reluctant to lend or require a higher interest rate in return.
Lenders use LVRs rather than the purchase price as the secured amount, because the purchase price may not be what the lender could sell it for.
Before applying for a business loan, think about what security you have or can acquire. Your financial institution can help you to look at various options. Loan security is designed to protect you and your lender.
This blog also appeared in the Newcastle Post November 21