Collateral Value

Definition

Collateral value is a financial term used to refer to the fair market value an asset has when securing a loan. The collateral value of assets is simply determined by comparing the recent sale prices of similar assets, or by having an asset appraised by a market expert.

Lenders mostly use collateral value to assess the level of risk involved with a particular loan application. An asset’s collateral value can be estimated in various ways including tax assessments, comparable transaction reviews, and consulting the opinion of market experts.

Collateral Value Explained

Collateral Value or Collateral Valuation (also known as Collateral Appraisal) is a finance methodology used by firms to evaluate the value of collateral assets linked to loans. There are different types of Collateral Valuation depending on the nature of the asset involved. These types include:

• Full Appraisal

• Automated Valuation Model

• Drive-by

• Desktop

• Indexed

• Purchase price

• Market to market

• Managing or Estate Agent

• Counterparties Valuation

• Hair cut

These types of valuation are peculiar to the situations where they are required. For example, if a loan is associated with a publicly-traded stock, to estimate the value, the lender will have to use the current market price of the stock or securities.

When it comes to granting loans, collateral value is a key aspect of processing applications for secured loans. It is a key aspect in secured loans because the lender will gain the right to obtain ownership of an asset or collateral if the borrower fails to pay back the loan. The purpose of the collateral is to enable the lender to recover their investment by selling the collateral. Therefore, it is important that a lender properly estimates the value of a collateral before granting loans.

In some cases, the collateral doesn’t measure up to the full amount of the loan. Typically, secured loans correspond to the collateral value of assets, which is known as the loan-to-value ratio (LTV). For example, if a lender provides a loan of $500,000 to purchase a property with collateral value of $600,000, the LTV ratio will be 90%. Usually, the collateral value of an asset must be in a 70% to 90% range of the loan provided.

The most common example of secured loan is the home mortgage, whereby, the house being purchased is used as collateral to secure the mortgage loan. In this case, if the borrower fails to meet the demands of mortgage payments, the lender or bank can sell the house to recover their money.