Cosigner vs. Collateral for a Small Business Loan

Whether you’re starting a business or looking to grow an existing one, chances are you need cash. But if you’ve been turned down for an unsecured loan, you may be wondering what your options are. Two ways of obtaining financing when you’ve previously been denied are:

 

  • Finding a cosigner, someone to accept responsibility for making loan payments should you fail to do so.
  • Putting up a valuable asset as collateral.

 

Because these options assure the lender she will recover her money when the loan is due, they can help you get approved. You may also qualify to borrow a larger amount, possibly at a lower interest rate, than if you were to take an unsecured loan without a cosigner or collateral.

 

While that sounds ideal, there are some serious consequences that accompany each alternative-especially if you can’t make the payments. Take a look at the risks and rewards of each option before making the decision to pursue either one.

 

Finding a Cosigner

Finding a cosigner can be a great way to secure a loan when you’d otherwise be denied, because now the bank has two parties guaranteeing the loan rather than just one. Failure to pay, however, can cause major headaches for you as well as your cosigner. Take a look at the pros and cons associated with this option before asking someone to cosign.

 

Pros:

  • Because of the cosigner’s additional credit, you may qualify for a larger loan amount than you would on your own.
  • You may be eligible for a lower interest rate, meaning smaller monthly payments and less total interest paid.
  • Making your payments in a timely fashion on this loan can improve your credit score, meaning the next time you apply for a loan, you may not need a cosigner.

Cons:

  • You might get approved for a loan amount that’s larger than you can pay based on the credit and assets of your cosigner. Be sure to only borrow an amount that you’re easily able to pay back each month.
  • The cosigner is accepting responsibility for your behavior. If you as the primary borrower can’t pay, the cosigner must shoulder that burden alone.Should the cosigner not be able to pay either, it’s considered a default by both parties. If legal action is taken to recoup the balance of the loan, the cosigner will be sued as well.
  • In the case that you default on the loan, the cosigner’s credit be damaged, which means they may have a harder time securing a loan down the line. Potentially, the cosigner’s assets could be in danger as well.
  • If you’ve asked a friend or family member to serve as your cosigner and you stop making payments, chances are that relationship is going to become strained very quickly. A good rule of thumb is this: If you wouldn’t ask that person for a personal cash loan, don’t ask them to cosign.

Putting Up Collateral

Collateral is an additional form of security which can be used to secure a loan when you’d otherwise be denied. Typically, collateral is valuable, tangible property, such as the business owner’s home or the business’ inventory or equipment, which will be sold by the bank to repay the loan in the event that you fail to make loan payments. Take a look at the pros and cons of using collateral to secure a loan.

 

Pros:

  • If you’ve been turned down for unsecured financing, putting up collateral can help you get that loan because the bank will now be able to sell your asset to cover the balance.
  • Using collateral can speed up the loan application process, allowing you to be quickly and easily approved.
  • You can request a larger loan amount than you can with an unsecured loan because there’s less risk to the lender.
  • You can often secure a lower interest rate because, again, the lender has a guarantee the loan will be paid.

Cons:

  • Depending on the value of your collateral, you might get approved for a higher loan amount than you can pay. Be sure to do the math and make sure you can make your monthly payments, and only borrow what you need.
  • If for whatever reason you’re unable to make the loan payments, the bank will seize your assets. It’s important to be realistic about the possibility of default. There could be dire consequences for both your business and your personal life should you lose the property you offered as collateral.
  • Your assets might not be worth as much as you think. Many people fail to take depreciation into account and find that their valuables are worth less than they anticipated. This means they may not qualify for the loan amount they had in mind. Consider finding an independent appraiser so you know where the bank will value your assets; this can eliminate unpleasant surprises.
  • If you don’t own a home, vehicle, or other piece of property that can be used as collateral, this option isn’t available to you. Those renting an apartment, leasing a car, or who have a business that doesn’t have equipment or inventory to offer as collateral are out of luck.

 

Securing a cosigner or putting up collateral can help you quickly and easily qualify for a loan if you’ve been turned down on your own, but neither is without risk. Before approaching a possible cosigner, be aware of the far-reaching consequences of your request. Likewise, if you’re thinking of offering up an asset as collateral, make sure it’s one that won’t cause you excessive hardship should you lose it in the event you’re unable to make the payments on your loan.

 

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