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When seeking funding, particularly for a business, lenders may ask for security to mitigate their risk. While a request for security should be considered carefully, demonstrating your commitment to the venture often means being prepared to offer assets. It's important to understand that while a lender accepts some risk, the primary risk for your business venture ultimately rests with you.

Why Do Lenders Ask for Security?

Lenders require security as a form of insurance should a loan not be repaid as arranged. They look for assets that possess three key attributes:

Understanding these attributes clarifies the logic behind granting security. If the debt isn't repaid, the assets can be seized and sold by the lender to recover their funds. This process is straightforward.

What Makes Property Good Collateral?

Some lenders have clear internal policies on when security is required, regardless of the specific loan proposition. For certain types of financing, like hire purchase agreements, the asset being purchased often serves as its own security. However, for other loans, there are no universal guidelines on what constitutes a reasonable security request; it depends entirely on the specific loan proposition and your financial situation. You'll need to assess if the request is reasonable for you and, if not, explore alternative funding options.

The Risks of Using Your Family Home as Security

If you have a family, securing a loan with your family home is a significant decision that requires careful consideration. Always remember the implications: if your business fails and you default on the loan, your family home could be sold to repay the debt.

Before granting a mortgage on your home, you must be absolutely certain that your business proposals are sound and secure. While lenders want to see you succeed, they will not hesitate to seize your assets if things go wrong. They will pursue repayment diligently. Therefore, it's essential to have the full commitment and understanding of your spouse or partner. They need to be convinced that the risks of losing your home are minimal.

What Happens if Your Business Struggles?

While we've emphasized the risks of providing security, a lender will typically only take such steps if there's no other alternative. If your business faces failure and still owes money to creditors, including a lender holding security, you must address the situation proactively. Ignoring it will likely lead to greater losses.

Your first step should be to seek an alternative way to earn income. If you can propose an acceptable alternative repayment program for your debts, it's unlikely that the lender holding the security will immediately attempt to realize it. Seizing security is always a lender's last resort. They generally prefer to avoid the potential negative publicity associated with a forced sale of a family home. If you encounter a situation that could lead to business failure, communicate openly with your lender; they are often sympathetic and willing to work with you.

Lender Requirements for Property Security

Your house is likely your most valuable asset, even if it already has an existing mortgage. When using it as security, the lender will require full details regarding its ownership (sole name or with a partner) and, importantly, who actually lives in it. This is because occupants who don't own the property may still have a legal vested interest.

Before lending money against your property, the lender will require several formalities beyond just signing a legal mortgage:

In some cases, the lender may require a full professional valuation. In most instances, a lender will conduct a personal visit to ensure the property is in reasonable condition and suitable as security.

How Do Lenders Value Your Property as Collateral?

Once a valuation is obtained, lenders typically discount this value by 10% to 30%. This discount acts as a contingency factor and helps cover the costs of sale should the property need to be sold to repay the debt. If you are not occupying the property yourself, the valuation may be discounted even further, potentially by as much as 55%.

Any prior mortgage is then deducted from this residual value to calculate the final valuation of the security. This approach might seem strict, but if the lender takes possession, they aim for a quick sale. They will value the property and offer it for sale at a price that ensures a swift disposal. You will also be responsible for meeting all external costs associated with taking out the mortgage, along with a security fee to cover the lender's administrative costs.