Asset-Based Lending Explained

Asset-based lending is the practice of extending financing based on collateral placed with the lender. It is the opposite of unsecured lending, which means the borrower places no collateral for the loan. Asset-based loans are partially based on the borrower's financial status and partially based on the value of the asset. Because an asset-based lender assumes less risk than an unsecured lender, the loans will typically be available at a lower interest rate. Better loan terms may also be available on secured loans as opposed to unsecured loans. Any asset can be used hypothetically, but some common forms of asset-based lending are:

Car Lending

Car loans are often the first type of asset-backed loan a borrower pursues. With these loans, the lender holds onto the car title until the loan matures and is paid off. The borrower makes monthly payments, called installments, against the beginning amount of the loan, called the principal. The principal and installment are terms common to all installment loans. Installment loans are common for most asset-backed loans. Revolving loans, where a purchaser determines how much to spend and pay back each month like a credit card, may also be based on an asset.

Mortgage Lending

Mortgage loans use a home deed as collateral. Typically, the deed to the home is held with the lender until the loan is paid off in full. The home may be seized, called a foreclosure, if the borrower fails to meet the terms of the loan. Homes may also be used in other types of asset-backed lending including home equity loans or home equity lines of credit. In these loans, the equity a borrower has built up in a home can be used to finance a new purchase even though the borrower does not yet own the home in full.

Savings-Secured Lending

A borrower can use money in a savings account with a particular lender to get a loan. This way, the borrower can leave the funds in savings and continue to earn dividends while still achieving short-term liquidity. The dividend payments on the savings account can be subtracted form the overall cost to finance the loan, making these loans particularly inexpensive. They are a good option for high risk or bad credit borrowers because they present many ways to reduce the cost of a loan that would otherwise be very expensive.

Stock-Secured Lending

Stock-secured loans are very similar to savings-secured loans because the asset continues to generate dividends and profits despite being held by the lender. In this case, the lender holds on to the initial stock certificate. Financing is extended as a portion of the total value of the stock certificate being held. Lenders never finance the entire amount of the stock because they like to have an asset that is more valuable than the loan itself to ensure against default. Stock loans allow many people to hold onto their savings and investments instead of trading them in when they need cash in the short run.