How to avoid the need for collateral when borrowing

Mike has just received a call from his bank requesting him to present a title deed as collateral before his application for a business loan is approved.

Because of uncertainty over meeting his future loan obligation, Mike is confused on whether to rescind the bank offer and preserve his parcel of land or to present the title as a guarantee to secure the money he intends to use for the expansion of his business.

Overwhelmed with the risk of losing his precious land in the event of default, Mike opts to reject the loan offer to protect his land.

Many potential borrowers face Mike’s dilemma when seeking credit facilities from lenders to pursue their financial plans.

Like other businesses that offer services or products on credit, banks face the risk of default each time they extend credit to clients.

Subsequently, a potential borrower’s refusal to present an asset as collateral often serves as confirmation of the risk of default.

Consequently, the opportunity cost of rescinding a loan offer to preserve an asset is quite high.

How can one secure a loan without putting their assets or collateral at risk? Below are some of the factors worth considering.
Borrow only what you can service

Any call for collateral by your lender shows that you can service the loan, but what they are not sure of is whether you will repay the loan without defaulting.

As a requirement, collateral remains at the custody of the lender and is returned once you clear the loan repayment.

To safeguard your collateral, it is advisable that you only apply for a loan facility that you can comfortably service.

Build your credit profile as reputational collateral

Remember that if you have a negative credit report or lower credit score, which shows that you have a bad repayment history, banks will treat you as a high default risk.
Depending on its lending policy, a bank could either reject your application outright or consider lending you on condition that you provide security.

To preserve your collateral, it is advisable to build your credit history into reputational collateral.

Go for loans below the threshold or unsecured loans

Sometimes you could have a clean credit report with proven financial ability to pay but the loan you apply for could be way beyond the bank’s set threshold amount for an unsecured loan.

As part of its credit policy, the bank will extend you the facility subject to submitting collateral.

It is therefore advisable to go for loans that are below the threshold for collateral requirement or go for unsecured loans.
Take note that unsecured loans come at relatively high interest rates.

Work on early loan repayment

If a bank is in custody of your collateral, you should work on an early repayment plan.

For instance, if you are not sure of your job security, work on early repayment whenever you get some extra cash so as to reduce the amount of loan owed.

Likewise, should you foresee any difficulty in meeting your loan repayment obligations, approach your lender to restructure the loan to avoid any punitive measures that could be taken to recover the loan.

This could involve spreading the loan over a relatively longer time to reduce the repayment amount.

Arrange for collateral substitution

Any default can prompt the lender to dispose the asset to recover outstanding balance.

To be safe, consider negotiating for collateral substitution once you feel that you have repaid a substantial amount of the outstanding loan.

You can approach your lender and renegotiate for collateral substitution where you can substitute the existing security, for instance a title deed for your home, with that of a lesser value such as your car log book.

Should a default occur before you clear the loan, the bank will dispose the asset with the lesser value to recover the debt and save your home.

Opiyo is a personal financial coach with Tolerance Employee Financial Advisors Ltd. isaiah.opiyo@toleranceadvisors.com