BANK LOANS-SECURITY
March 18, 2009 by Muhammad Haidar
Filed under Business, House Mortgage, Loans, Muhammad Haidar, Other - Business & Finance
Introduction: Banks lend money to the public, for various purposes, like purchase or construction of a home, for purchase of consumer goods like a TV, Music System, etc. Banks also finance businesses, both manufacturing and services. Apart from all these, they also extend personal loans to members of the public.
This service provided by Banks, namely, financing, or more commonly called lending, is fraught with several inherent risks. Loan defaults may occur for more than one reason, including reasons beyond the control of the borrowers, like for example, in case of floods or a Tsunami, that may wipe out the assets of the borrower, apart from rendering him incapable of restarting his business immediately. The most serious risk to Banks in the lending process is the risk of non payment of the loan by the borower. Imagine a situation where none of the borrowers of Banks repay the loans availed of by them! This could lead to a collapse of the Banking industry!
The current spate of Bank failures in America and elsewhere, is, in good part, on account of borrower defaults. Whereas, in an ideal situation, every borrower repays the loan availed by him, from the Bank, in real life, this does not happen. Many a time, borrowers, both individuals and institutions, fail to keep up their repayment committments, affecting the well being of the lending Bank. Sometimes, there are even genuine reasons why borrowers become defaulters.
This being the case, Banks invariably, have in place, norms and procedures that they follow before parting with money to a borrower. Banks examine and evaluate credit proposals, as to their viability and feasibility, both technically and financially, before taking a decision to grant a loan. Each loan is appraised individually to ascertain the soundness of the proposal and only then a decision to grant a loan is taken. Among the various precautions observed by the Banks to safeguard their interests in the lending process, is the obtention of security for the loan extended by them.
Definition of Security: Security, in relation to a loan extended by a Bank to a borrower, means, an asset, of any kind or description, having certain qualities, among them, monetary value, that can be possessed by the Bank, in the event of default, and applied toward repayment of the loan.
Having extended the loan to the borrower, Bank would naturally like to ensure that the loan is repaid with the interest thereon. That is, Bank would want to secure the loan. This is done by way of creating a charge against the asset financed by the Bank. The type of charge created depends on the nature of loan, and the security.
Basically, there are two types of securities availabe to Banks to secure a loan. They are Primary security and Collateral security.
Primary Security refers to the asset directly created out of Bank finance. For example, where a Bank finances the purchase of a home, the home is the primary security. In the same way, a car purchased with the help of a Bank loan, is the primary security for that loan. Bank creates a charge against this primary security, to secure its loan. This charge give the Bank the legal authority to dispose off the asset, and apply the proceeds therefrom, to the loan amount in default.
Collateral Security refers to certain additional security obtained by the Bank to secure the loan, in addition to the primary security. For example, say, a Bank has financed the purchase of machinery by a Pharmaceutical manufacturing company. This machinery would be the primary security for this loan. In addition, the Bank may obtrain collateral security in the form of the factory building and land owned by the company, as an additional security. This will secure the Bank further and safeguard its interests in the event of the primary security not having sufficient value to liquidate the loan. Many a time, it so happens, that on account of adverse market conditions, the value of the primary security gets eroded, exposing the Bank to a higher level of risk han it had originally bargained for.
In addition to the above discussed securities, there is also the scope of securing the loan with the help of personal security of the borrower. Obtaining personal security of the borrower enables the Bank to proceed against the borrower and his personal estate, in order to recover the loan.
Qualities of a Security: In order that a security may provide a real means of liquidation of a loan in part or in full, the concerned asset must have the following important qualities, among others:
1. Valuable Security: A security obtained as a cover against default, of the borrower, in repayment of the loan, must have some monetary value that can be realised and adjusted toward the loan. Intrinsic value alone would not be helpful to the Bank in mitigating the problem arising out of a default.
2. Marketable Security: Even though a security may have a monetary value, it may not be possible to encash the value as and when needed by the Bank, because it may not be easily marketable. That is, it may not be easy or even impossible to dispose off the security and realise its proceeds, for various reasons.
For instance, the asset obtained as a security for a loan, may not be in demand, at the time it is required to be encashed or realized and credited to the loan amount in default.
3. Stable Security: Stability of security here means the stability of the value of security. Certain securities have widely fluctuating values, depending on market and other conditions. As a rule, Banks prefer securities that are not prone to market gyrations, and offer a reasonable chance to the Bank to have it adjusted to repay a good part of the loan in default, if not the entire loan.
4. Transferable Security: The security offered by the borrower to secure the loan, must have the quality of transferability. That is , the ownership, or the interest in the security, must be capable of being transferred to the lender, without too much effort and expemses.
As can be seen from the above, securing the loan extended by the Bank is of vital importance and also necessity to the Bank, as otherwise, it may jeopardise the interests, or even the survival of the Bank. That apart, securing a loan with an asset of the borrower increases the stake of the borrower, who would have more reasons to make his venture a success by doing his best.
This home truth has been forcefully brought forth in the current economic crisis, in which many Banks have realized their folly in not properly securing their loans.
Starting Out With a Personal Bank Loan
You’ve got a great idea for starting a new business, and the only thing holding you back is, you guessed it, lack of funding. You don’t want to borrow from family and friends and since the finance required is quite modest, no venture capital firm will bite. So, where do you go? A personal bank loan might be just what the doctor ordered.
Under what circumstances should I consider taking one?
A borrower may resort to a personal bank loan when he finds himself suddenly cash strapped, and is in need of a quick injection of funds. This is one of the most in-demand financial products, but surprisingly, not all banks offer them, as they would rather push a more profitable product like a credit card. However, for business related needs, a personal bank loan is much more suitable and offer greater flexibility. What’s more, it usually carries a lower interest rate than a credit card does.
What security will I have to offer?
A personal bank loan may be secured or unsecured. In the former, the lender will insist on some kind of guarantee that can be enforced in case of default. Typically, this takes the form of collateral – where certain assets are pledged with the lender, who will have rights to the same in case the borrower does not pay up. This poses serious challenges to a new entrepreneur, who may not have built any assets yet, and even if he has, may not be a position to place them at risk.
This is where an unsecured personal bank loan can come to his rescue. An unsecured personal bank loan has no such strings attached other than that the borrower must have a clean credit record (but you can be sure that no bank will blindly sign away their money, so be prepared for onerous scrutiny and loads of paperwork and be cautious about any personal guarantees that you may have to furnish).
I don’t think my bank will give me one.
In recent times, while the popularity of the unsecured personal bank loan has been on the rise, ironically, its supply has tightened. This has resulted in the entry of other types of lending institutions, including those that are web based, which offer low interest rates and superb service. A couple of examples are E-LOAN and America One Unsecured, but we recommend that you investigate other sources as well.
While taking a personal bank loan has its pluses, be aware that it’s not always the ideal solution. Don’t opt for one just because it seems expedient. Consider other important issues, including overall cost and alternative financing options before you go ahead.
Secured Bank Loans – Advantages of Getting Secured Versus Unsecured Bank Loans
Most people find themselves strapped for cash at times and are held back by the lack of money. Maybe you don’t have money to buy a car or fulfill some other wish, or maybe it’s more of a personal matter. If you’ve never been in such a situation until now, then consider yourself happy.
Those of us that have been in situations such as this, will need from time to time a secured bank loan to help us through difficult times. What unsecured loans lack while secured bank loans have, is that you can use a collateral and get better deals because of it. Below are a couple of ways that a secured bank loan can help you:
Reduce Your Debt
You might think that taking loans to reduce your other loans sounds bad, but the truth is that secured bank loans can help you quite a bit to reduce your debt. You can use secured bank loans to cover five credit cards for example, instead of keeping track of each of them and repaying them individually.
The end result is that you will pay only one bill monthly, and the secured loan insures that you pay less. The lower interest rate insures that.
Remodel Your Home
Do you need to invest in a new roof for your house? Or you want to put a swimming pool behind the house. It doesn’t matter if you need it for your house or you just want to make it more comfortable, with the help of a secured bank loan you can do it.
A secured bank loan is also a home equity loan, which is determined by considering the house’s value and the mortage that was already paid off. There is another advantage here, the fact that by improving your house, you’re increasing its value, so you can also consider it an investment.
Take A Trip
You can also take a secured bank loan to have some fun and travel. Instead of saving for years for your dream vacation, you can take a secure bank loan to go to your Disneyland trip, seeing the pyramids from Egipt or any other dream you might have when it comes to travel.
If you’re comfortable with some debt, you can take that dream vacation without running into as much debt as if you used credit cards. Of course, the best solution would be to save that money instead of getting into debt, but if you need a loan, then a secured bank loan will work best.