How collateral works and examples on calculating loan-to-value ratios

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Transcript

All right, in this lesson we're going to talk about loan collateral and how to calculate LTV, otherwise known as loan to value and this is almost always the secondary source of repayment. When you are trying to get a business loan from a lender, there are some lenders as I may have mentioned earlier, that will make loans strictly on the collateral that you have to offer. And those are often called asset based lenders, but in general, most lenders will like some sort of collateral for your loan. And when you provide collateral to a lender that is called a secured loan, and those are definitely preferred, versus an unsecured loan where you're providing no collateral whatsoever. One note on the idea of secured versus unsecured, your signature or what is called a signature loan is considered unsecured, there's no additional collateral beyond you saying that you will pay the loan back so secured loans are different Definitely preferred compared to unsecured loans, that does not mean that if you do not have any collateral to offer that you can't get a business loan, it's just likely that the amount that you're going to be offered is going to be significantly lower than if you can provide some sort of collateral.

And so some fixed assets have value that a lender is willing to take as collateral. And the reason they take collateral is if you are unable to make your payments on that loan, the lender will then take that asset away from you and then sell it to recoup their funds. And that's why it's called the secondary source of repayment. A great example of this is your personal car loan. If you have a loan on your car, and you stop paying that lender after a period of time, they will come back and they will repossess it, sell it and try and recoup some of their funds. Typically, when they're going through this process, even the lender does not recoup the full amount of the loan.

And so that is why it is not the primary source of repayment collateral tips is not worth the true value of when a lender has to sell it because they're usually not in the business of selling that type of collateral. They try and sell it quickly and move on. Even true in real estate. So the lender coming in and taking your collateral away from you only comes into play if you choose not to pay him, which I hope you never do. Now, with your collateral, the value is determined typically through some sort of third party appraisal, if it's real estate, they might use a real estate appraiser to tell them the value whether that's residential or commercial. For cars, things like cars, though use na da or the Kelley Blue Book KBB.

For equipment and those types of collateral. Oftentimes, they'll ask an accountant to do an appraisal on that collateral or they may ask you for your bill of sale, which in that instance, is the value that they will use for that collateral. But since you're willing to pay that much for it, they may take that bill of sale and say well, we're going to take this as the appraiser On the collateral that you're offering to give us. So there's different types of collateral. The easiest way to think about these is to break them down into two categories, there are fixed assets, and then there are variable based assets. And the difference is a fixed asset is a asset, a piece of collateral that has a somewhat fixed value, it moves a little bit.

So obviously, real estate is the best example it can appreciate. Of course, it can depreciate as well. But it is a fixed asset in that the time that it is valued, it has a fixed value. There are variable assets, who the value of their, of that collateral of that asset can change pretty quickly, pretty regularly. So for fixed assets, we look at things like real estate, some sort of vehicle, whether it's a personal car that you use for business or a truck that you use for deliveries, maybe you offer as collateral, some equipment, maybe you're in the restaurant business and the equipment that you have is offered up as collateral to the lender. Or even in some instances, you can use your own cash as collateral.

I won't get into that today why you would use cash as collateral. But there are instances when it does make sense to do that, and provide the lender with that sort of collateral maybe as the full amount of the loan or a part of the loan. For variable assets. There are two main categories that fall into the this type of collateral they are accounts receivable, and that is bills that you are owed by people that you sold things to if you provide terms to your customers, if you say, Hey, I'm going to go ahead and give you the service or the product, but you don't have to pay me for the next 30 days. That's terms and that means you have an accounts receivable that is owed to you, that is a variable asset and that can be used as collateral. So can inventory.

If you sell a widget, the inventory of that widget or widgets can be used as collateral on your loan. Now, loan to value is the percent of the value of the asset that the lender will loan against and I'm going to go through some examples. And hopefully you'll start to grasp this. But when you, let's say, you're just going to use one. Now let's say that you need $100,000. And you're willing to get real estate as collateral on the loan, I'll show you in a second, where 80% is the typical loan to value.

And so if you need $100,000, or you have $100,000 piece of real estate, the lender will usually give you 80% of that value as a loan, and so they would give you $80,000. So you're wondering, well, where does that other $20,000 go? Well, what they're doing is they're reducing the amount they're willing to lend you reducing the loan to value to leave them a buffer, if they have a hard time selling that collateral. When they go to recoup it. Remember, just a few moments ago, I mentioned that they typically don't recoup the full value of the collateral because they try and sell it quickly. They're not in the real estate business.

They're not auto mobile dealers, so they don't do a good job of getting the value. So they reduce the amount and they calculate these loan devalues. Well, what happens if you need more than the value that they're willing to give? against that collateral, that remaining percentage is your what we call your liquidity injection. It's how much you have to put into the deal. And then in the next lesson, I'm going to talk about calculating liquidity and things like that.

So liquidity does typically come in the form of cash. Again, real estate is a great example of this. If you have $100,000 piece of equipment, and the lenders giving you an 80% loan to value against that real estate and also equipment, then that would be an 80% LTV, and no you cannot borrow your equity injection typically. So here's some typical ltvs. Again, this varies depending on the lender, some will go up or down depending on their comfort level with the type of asset that you're giving them as collateral but just as a general purpose. This should help you out on the left side of the side here under fixed assets real estate, typically you can get up to 80% of the residential value of the value of a residential property.

If we're looking at commercial property, typically you can get 75% from what's called an O or non owner occupied meaning that you own that real estate and you are only staying or occupying let's say your business only occupies say 40% of the overall square footage that is considered non owner occupied property. And so you could get 75% if you are owner occupying the property or occupying more than 51% of the square footage of that commercial real estate, then you can get upwards of 80 sometimes even 90% development land so just pure raw land, I'm sorry land that has been developed has the sewer in has maybe some roads has some lights and things like that up you can often get 65% and then pure raw land just grass growing out in the field. Sometimes you can get upwards of 50% of the value of that land toward toward your loan to value and use it as collateral vehicles you can often get 100% of those.

Again, the lender is probably going to lose a little bit of money but they'll do it and with the equipment you can get somewhere around 75 to 85% on used equipment and a lot of work. lenders these days are lending 100% of the value of brand new equipment out to businesses. And with cash. Again, this is generalization but you can generally get 100% of the cash that you put up as collateral back in the form of a loan. Sometimes they'll discount that a little bit, but just for general purposes, 100% is a good thing to think about. With variable assets.

It's a little bit less for a lot of these categories with accounts receivable, you can get 80% up to 90 days old, but they do consider accounts receivable and actually inventory both unsecured and quickly the reason they consider a month secure is because as I said, lenders are not in the business of whatever your business is selling widgets collecting being a receivables collector, and so they discount these heavily and they consider them basically unsecured even though they still will put a lien on your collateral so that they can take it and sell it. So accounts receivable 80% up to 90 days old. Why do they stop at 90 days old well because if you have bills that are due to you from customers that are 120 days old, they just consider them uncollectible. So they just ignore them. With inventory, you can usually get half the value of those widgets, and in the form of a loan, and then with investments, you can use investments as collateral.

So if you have an investment portfolio, but usually it's about 50% of the value of those investments, you can imagine why if you look at the stock market stocks vary up and down pretty rapidly, are called volatile. And so with investments, they'll usually give you 50% of the value of your portfolio. And within that portfolio, they'll often only use what are called Blue Chip stocks. So these are just the strongest the best stocks that you can get. Think of the apples of the world, the Amazons of the world. If you've got penny stocks in there and low grade companies, they're just going to discount those and still only take 50% of blue chips.

So quick example of how to calculate and LTV. So this first example you're buying a build building and you're going to owner occupy it as a reminder, that means you're If you're gonna hold down your own business will be in more than 51% of the square footage. And that building costs $100,000. So what would the LTV be? I'm going to run through all of these and then give you a moment, ask you to pause and then on the next slide, I'll show you the answers. In example number two, what would the LTV be on buying raw land that you want to build on?

If that land cost 60%? What would what would they be willing to loan you? And then on the last example, is you're going to finance some inventory using the numbers I've given you in the inventory is $50,000. What what amount would they use as a financing vehicle? Before I move to the next slide, go ahead and pause kind of work through these based on the previous slide, and then I'll show you the answers. So an example one you're buying the building the building costs $100,000.

This one should have been pretty easy for you since I gave you the example earlier. I think twice I did it if it's $100,000 with the typical LTV an owner occupied building being 80% then the lender would give you $80,000 that means your equity injection would be the remaining $20,000. An example number two, if you're buying raw land and you plan to maybe in the future build a new office building on it, the land cost $60,000 the typical LTV is around 50% and so that means the lender would give you $30,000 your equity injection as the business owner would be the remaining $30,000 in order to be able to buy that land at the full last. And in the last example, you're financing some inventory, the inventory is going to cost you $50,000 What will the lender give you in many examples, they will give you or traditional lenders will give you 50% of that inventory.

And so in this instance they would loan you $25,000 you would have to pay the remaining $25,000 as your equity injection with your liquidity your cash in order to finance that

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