Real property collateral: Overview, definition, and example
What is real property collateral?
Real property collateral refers to real estate (land or buildings) that is pledged as security for a loan or debt. When a borrower takes out a loan and offers real property as collateral, the lender has the right to take ownership of the property if the borrower defaults on the loan. This type of collateral is often used in mortgages, commercial loans, or other secured financing agreements. By using real property as collateral, the borrower can usually secure a loan with better terms, such as lower interest rates, because the lender has a physical asset to back the loan.
In simpler terms, real property collateral is real estate that a borrower promises to give to the lender if they can’t repay the loan.
Why is real property collateral important?
Real property collateral is important because it gives the lender more security in the loan agreement. If the borrower fails to repay the loan, the lender can take possession of the property and sell it to recover the funds. This reduces the lender's risk and makes it more likely that they will approve the loan. For the borrower, offering real property as collateral can help secure financing, often with better conditions, because it provides the lender with a valuable asset to fall back on if the borrower defaults.
For SMB owners, understanding how real property collateral works is crucial when considering taking out loans, as it can significantly impact loan terms and the financial security of the business.
Understanding real property collateral through an example
Imagine your company is seeking a loan to expand its operations. The bank agrees to lend you $500,000, but they require real property as collateral for the loan. You offer the bank a commercial building your company owns as collateral. If your business is unable to repay the loan, the bank has the legal right to take ownership of the building and sell it to recover the loan amount. As long as you make the required payments, you retain ownership of the property.
In this case, the building serves as real property collateral, securing the loan and protecting the lender in case the loan is not repaid.
Example of a real property collateral clause
Here’s an example of what a "real property collateral" clause might look like in a loan agreement:
“The Borrower agrees to pledge the commercial real estate located at [address] as collateral for this loan. In the event of default, the Lender shall have the right to foreclose on the property and sell it to recover the outstanding loan balance, including any applicable interest and fees.”
Conclusion
Real property collateral is a crucial concept in secured lending, where real estate is used as security to guarantee loan repayment. For SMB owners, offering real property as collateral can help secure financing with better terms, but it also comes with the risk of losing the property if the loan is not repaid. Understanding the implications of real property collateral ensures that businesses make informed decisions when taking out loans, protecting both the business and the lender in the process.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.