Vena Lesson: Collateral Doesn’t Mean Everything’s OK

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During credit activities, investors face such a risk: what to do if borrowers don’t settle the loan? Generally, we have a widely used method, mortgage, despite credit. And there’s a similar method, pledge, however, we won’t discuss the difference between mortgage and pledge in this passage.

Even if borrowers is unable to pay the loan, collateral can work, so loans with collateral are welcome among investors. However, collateral doesn’t mean everything’s ok, problems still remain. Kinds of collateral also differs. Now let’s see what characteristics do kings of collateral show.

To study on collateral, we should focus on following characteristics:

1.The authenticity of the collateral. In most credit relationship, collateral will not be actually handed over to investors. So investors have to make sure if the collateral do exists, instead of a fiction by borrowers or intermediary platforms.

2. Sufficient value. That means the value of collateral should cover the amount of the loan, and during the loan period, the value will not decrease to a insufficient level. To make sure of that, usually there’s a ratio between the loan amount and the value of collateral, called loan-to-value ratio. A $1,000,000 estate and a $700,000 loan make the loan-to-value ratio 70%. If the value of the collateral fluctuates fiercely, and there’s a high loan-to-value ratio, that may be dangerous. On the other hand, collateral like estate can be mortgaged for two or more times, which obviously makes a negative effect on the collateral. Investors should take care.

3. Liquidity. Usually, when borrowers can’t pay the loan, investors do not need the collateral itself, so there’s a problem of liquidating. Obviously, collateral with higher liquidity is more welcome, which should be considered by investors.

Now we can focus on common kinds of collateral.

Estate. We can ensure the authenticity with certificate of property rights and photos of the estate. However, if the information disclosure is not transparent or complete, investors should be on the alert. Normally the value of the estate will not fluctuate fiercely, and is easy to judge, while it is necessary to pay attention to the problem of second mortgage. It’s not hard for estate to liquidate, but that kills time, investors have to experience a long period along with lots of legal matter. Individual investors may have to rely on intermediary platforms to solve that.

Vehicle. It is easier to counterfeit a certificate of a car than that of a house. And a car may have a fiercer fluctuation, no appreciation, just depreciation, even damaged in an emergency like a traffic accident. Investors can judge the value by brand and version, but they are unware of the vehicle condition, which may make the collateral insufficient. On the other hand, it much easier to deal with a car than a house.

Financial assets, like notes, treasury bills, accounts receivables, etc. Such items have different characteristics, investors can judge the authenticity, value and liquidity based on specific conditions.

A new alternative is cryptocurrencies. To be a kind of collateral, cryptocurrencies have obvious advantages, such as impossible to counterfeit, easy to deal with, high liquidity. The only problem is the value fluctuates hard. Of course, this problem can be somewhat solved: if the price of cryptocurrency drops to a suitable level, we can inform the borrower to supply more cryptocurrency, or the loan will be right stopped and the collateral will be liquidated. So generally, cryptocurrency can be a new collateral with easier risk controlling.

Anyway, when investors are considering some kinds of financial products, dimensions above should be token into consideration to protect one’s capital. However, actually we can hardly find collateral with excellent authenticity, value and liquidity at the same time, so we have to make our choice based on our needs, or pick intermediary platforms with better ways to avoid the disadvantages of the collateral.

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