What is collateral value?
The term collateral value refers to the fair market value of the assets used to secure a loan. The value of collateral is usually determined by looking at recent sales prices for similar assets or having the asset appraised by a qualified appraiser.
Key points to remember
- Collateral value refers to the amount of assets that have been put in place to secure a loan.
- Lenders often use this value to estimate the level of risk associated with a particular loan application.
- A variety of methods can be used to estimate the value of collateral, including reviewing comparable transactions, using tax appraisals, and consulting subject matter experts.
Understanding the Value of Warranty
Collateral value is one of the main aspects that lenders consider when considering applications for secured loans. In a secured loan, the lender has the right to obtain ownership of a particular asset – called the “collateral” of the loan – if the borrower defaults. In theory, the lender should recover all or most of its investment by selling the collateral. Therefore, estimating the value of this collateral is a key step before any secured loan is approved.
Loan to value ratios
The size of a secured loan relative to its collateral value is known as the loan-to-value (LTV) ratio. For example, if a bank gives an $800,000 loan to buy a house with a collateral value of $1 million, its LTV ratio would be 80%.
Residential mortgage and collateral value
Secured loans can be granted for all types of property. One of the most common types of secured loans is the home loan, in which the house is given as collateral to secure the mortgage loan. In this situation, if the borrower fails to make their mortgage payments, the mortgage lender can sell the home to recoup their investment.
Meanwhile, the home’s collateral value is usually determined by relying on an appraiser who specializes in real estate. Other valuation metrics, such as recent tax valuations or comparable transactions, can also be viewed.
Example of collateral value
Depending on the type of asset used as collateral, collateral value methods may differ. For example, if a loan is secured by publicly traded stocks, the current market price of those securities can be used to estimate its collateral value.
In other cases, the collateral used may be rarely traded in the market. For example, a borrower may offer collateral in the form of private equity or alternative assets, such as rare art or collectibles. In these situations, a valuer may need to use specialized valuation methods, such as calculating the value of private stocks using discounted cash flow (DCF) analysis. Meanwhile, fine art and other rare items may need to be appraised by specialists familiar with the private collector and auction markets for these types of assets.
Typically, the loan amount given by a lender will be between 70-90% of its collateral value. For example, in the case of mortgages, lenders traditionally offer 80% financing, which means the borrower will be required to provide a 20% down payment. However, the exact size of the loan will depend on several factors, such as the perceived reliability of its collateral value, the current state of the market, and the borrower’s credit rating.