If the loan required cannot be justified by the borrower's financial statements alone, a pledge of security may bridge the gap. The types of security are:
- Endorsers
- Co-makers
- Guarantors
- Assignment of leases
- Trust receipts and floor planning
- Chattel mortgages
- Real estate
- Accounts receivables
- Savings accounts
- Life insurance policies
- Stocks and bonds.
In a substantial number of States where the Uniform Commercial Code has been enacted, paperwork for recording loan transactions will be greatly simplified.
Endorsers, Co-makers, and Guarantors-
Borrowers often get other people to sign a note in order to bolster their own credit. These endorsers are contingently liable for the note they sign.
If the borrower fails to pay up, the bank expects the endorser to make the note good. Sometimes, the endorser may be asked to pledge assets or securities too.
A co-maker is one who creates an obligation jointly with the borrower. In such cases, the bank can collect directly from either the maker or the co-maker.
A guarantor is one who guarantees the payment of a note by signing a guaranty commitment.
Both private and government lenders often require guarantees from officers of corporations in order to assure continuity of effective management. Sometimes, a manufacturer will act as guarantor for customers.
Assignment of Leases-
The assigned lease as security is similar to the guarantee. It is used, for example, in some franchise situations.
The bank lends the money on a building and takes a mortgage. Then the lease, which the dealer and the parent franchise company work out, is assigned so that the bank automatically receives the rent payments.
In this manner, the bank is guaranteed repayment of the loan.
Warehouse Receipts-
Banks also take commodities as security by lending money on a warehouse receipt.
Such a receipt is usually delivered directly to the bank and shows that the merchandise used as security either has been placed in a public warehouse or has been left on your premises under the control of one of your employees who is bonded (as in field warehousing).
Such loans are generally made on staple or standard merchandise which can be readily marketed. The typical warehouse receipt loan is for a percentage of the estimated value of the goods used as security.
Trust Receipts and Floor Planning-
Merchandise, such as automobiles, appliances, and boats, has to be displayed to be sold. The only way many small marketers can afford such displays is by borrowing money. Such loans are often secured by a note and a trust receipt.
This trust receipt is the legal paper for floor planning. It is used for serial-numbered merchandise.
When you sign one, you-
- Acknowledge receipt of the merchandise,
- Agree to keep the merchandise in trust for the bank, and
- Promise to pay the bank as you sell the goods.
Chattel Mortgages-
If you buy equipment such as a cash register or a delivery truck, you may want to get a chattel mortgage loan. You give the bank a lien on the equipment you are buying.
The bank also evaluates the present and future market value of the equipment being used to secure the loan:
- How rapidly will it depreciate?
- Does the borrower have the necessary fire, theft, property damage, and public liability insurance on the equipment?
The banker has to be sure that the borrower protects the equipment.
Real Estate-
Real estate is another form of collateral for long-term loans. When taking a real estate mortgage, the bank finds out:
- The location of the real estate,
- Its physical condition,
- Its foreclosure value, and
- The amount of insurance carried on the property.
Accounts Receivable-
Many banks lend money on accounts receivable. In effect, you are counting on your customers to pay your note. The bank may take accounts receivable on a notification or a non-notification plan.
Under the notification plan, the purchaser of the goods is informed by the bank that his or her account has been assigned to it and he or she is asked to pay the bank.
Under the non-notification plan, the borrower's customers continue to pay you the sums due on their accounts and you pay the bank.
Savings Accounts-
Sometimes, you might get a loan by assigning to the bank a savings account. In such cases, the bank gets an assignment from you and keeps your passbook.
If you assign an account in another bank as collateral, the lending bank asks the other bank to mark its records to show that the account is held as collateral.
Life Insurance-
Another kind of collateral is life insurance. Banks will lend up to the cash value of a life insurance policy. You have to assign the policy to the bank.
If the policy is on the life of an executive of a small corporation, corporate resolutions must be made authorizing the assignment. Most insurance companies allow you to sign the policy back to the original beneficiary when the assignment to the bank ends.
Some people like to use life insurance as collateral rather than borrow directly from insurance companies. One reason is that a bank loan is often more convenient to obtain and usually may be obtained at a lower interest rate.
Stocks and Bonds-
If you use stocks and bonds as collateral, they must be marketable. As a protection against market declines and possible expenses of liquidation, banks usually lend no more than 75 percent of the market value of high grade stock.
On Federal Government or municipal bonds, they may be willing to lend 90 percent or more of their market value.
The bank may ask the borrower for additional security or payment whenever the market value of the stocks or bonds drops below the bank's required margin.
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