Definition and Examples of Collateral Value
Collateral value refers to the total value of an asset used as collateral to obtain a loan. Your bank will assess the collateral value by comparing it to similar assets that have been sold or by using a professional appraiser. Home appraisals are often conducted to determine the fair market value of the property. There are many different types of collateral you can use, including real estate, vehicles, cash, intangible assets, inventory, and invoices.
How Collateral Value Works
For some types of loans, your bank will require collateral to secure the loan. If you default on the loan – meaning you stop repaying it – the bank can seize the asset you used as collateral and sell it to recover the lost funds.
Before the bank can give you a loan, they must first determine the actual value of the asset. The fair market value of the asset is what is known as the collateral value. You can determine the collateral value by looking at what similar assets have sold for or by having the item appraised by an expert.
A home appraisal is a good example of this. Home appraisals are conducted by licensed professionals who inspect the property and determine its true value. They will consider factors such as square footage, condition, and quality of the home. They will also look for any potential issues that may affect the fair market value of the home.
The appraiser also considers current market trends and compares the home to similar properties that have sold in the area. If the appraisal shows that the home’s value is less than the sale price, the bank is likely to offer you only the amount that corresponds to the appraised value of the home. You may need to try to lower the price of the home or you may need to pay more cash.
The home appraisal will also determine your loan-to-value (LTV) ratio. If the LTV ratio is less than 80%, you may be able to obtain a lower interest rate. If it is higher – such as if you are making a down payment of less than 20% – you may have to pay private mortgage insurance (PMI).
Types of Collateral
There are different types of collateral that come with varying requirements.
Real Estate: Real estate is one of the most common types of collateral used to secure a loan. It is often used to secure mortgages, personal loans, and even business loans. For example, most borrowers use their properties as collateral for a home loan when buying or refinancing.
Vehicles: If your vehicle is paid off, you may be able to use it as collateral for a loan. You can also use your car title to secure what’s known as a title loan, although it is known to be costly.
Cash: Some borrowers may choose to put a certain amount of cash down to secure a loan. For example, you may be able to use the money in your bank account to secure a loan. If you default, the bank has the right to liquidate your accounts to recoup the funds they lost.
Intangible Assets: Some technology companies use intangible assets to secure business loans. This includes software, trade names, and intellectual property. However, it may be difficult for the bank to assess your intangible assets.
Inventory: Businesses looking to obtain a business loan often use inventory to secure the loan. If you default on the loan, the bank can sell the items listed in the inventory as collateral.
Invoices: Companies can also use outstanding invoices as collateral to secure a loan. If the company defaults on its loan, the bank can collect unpaid invoices. This is sometimes referred to as invoice financing or accounts receivable financing.
Source: https://www.thebalancemoney.com/collateral-value-5197903
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