Asset Based Loan

An asset based loan is used to protect banks from the inherent risks of lending people and businesses money for purchases and investment. An asset based loan may be one in which either the loan is used to purchase an asset that will serve as the collateral, or one in which property will serve as collateral to purchase another piece of property.

For individuals, the best example of an asset based loan is a car loan or home mortgage. A car loan is necessarily backed by the value of the car, and the bank’s name remains on the title for the duration of the loan. The same is true for a home mortgage. A loan is secured by the value of the home, which is used as an asset to back the loan. It is only after a home mortgage is repaid or a car loan paid off entirely that the title is delivered to the car buyer or homeowner. Until that time, the possession of the vehicle and car are legally entitled to the bank.

For businesses, asset based loans are the new necessity in commercial lending. Typically, an asset, whether it be a list of accounts receivables or a whole building is used to back a future loan. More so than in individual lending, a business will often put up collateral to securitize a loan for another purpose. For example, a small retailing business might decide to open a new store. To receive funding for the inventory, new hires, and advertising expenses, a business can accept an asset based loan against a current location that it owns outright. The bank is protected by the right to ownership of the real estate if the borrower defaults and the business gets a lower rate of interest on the loan because the loan is securitized.

Asset Based vs. Unsecured
Asset based loans are typically accepted by individuals and businesses that cannot borrow unsecured money from a lender. They may have:

  • Little or no income
  • A bad repayment history
  • Zero cash for a down payment
  • A need for very large financed amounts

In an asset based setting, the asset is evaluated for its market value. Then, the lender will tell a borrower how much can be loaned against the property with a LTV model. In a loan-to-value appraisal, the market value of the asset is found, and then discounted.

If, for example, a business owns property worth $1 million, then a LTV value might be 65%, or $650,000. The bank is telling the borrower that they recognize the immediate liquidity value at $650,000, and would be comfortable lending that amount against the asset. The same is also true for smaller loans. Pawn shops, for example, often loan money to borrowers based on 40-70% of an assets value. If the loan goes uncollected, then the pawn shop can sell the collateral for what it is worth to recoup the money. If the borrower comes back to repay the loan, then the borrower can keep the property.

Get the best deal
Prospective borrowers should look for the best deal on a risk-to-reward basis. Let’s consider an example scenario in which a borrower wants to pay for college, but isn’t sure about their future earnings.

A borrower could go to a private student loan lender and receive $10,000 in loans at 4% interest. On the other hand, a bank might offer a 10% rate on a personal line of credit, which can be used for any purpose.

The personal line of credit costs more money, but it is not secured. If you cannot pay on an unsecured loan, then there is no necessity to pay. Instead, such a loan is secured by your credit score, and nothing more. A student loan, however, is asset-backed by your future earnings—you have to pay back your student loans no matter what.

In this case, the personal line of credit only makes sense if you believe there is a greater than 6% chance that you can’t repay the loan. In such a case, it may make more sense to pay more money for the loan, knowing that if financial difficulties arrive that you can walk away without problems.