The collateral coverage ratio (CCR) is a calculation that compares the discounted collateral value (DCV) with the total loan amount to ensure proper coverage. It is calculated by dividing the DCV provided by the amount borrowed. It can be used by lenders to evaluate the maximum loan limit eligibility of a borrower, and most lenders use 1.0 as a minimum acceptable CCR but will increase this ratio based on borrower risk and creditworthiness.
You can use our calculator to determine the CCR when you have the collateral value, discounted collateral percentage, and loan amount.
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Collateral Coverage Ratio Formula
Calculating the collateral coverage ratio is relatively simple:
| Collateral Coverage Ratio | = | Discounted Collateral Value |
| Total Loan Amount |
Discounted Collateral Value (DCV)
When determining the maximum borrowing limit of a borrower, a lender will discount the collateral that’s used to secure the loan. This is to account for potential depreciation of the collateral through normal use, changes in property values, or collection costs in case a borrower defaults.
It’s standard for lenders to require that the loan amount can’t be more than the discounted value of the supporting collateral. These discounted rates will vary based on the type of collateral and the potential for decline in value. Real estate often has a DCV of up to 80%, while furniture, fixtures, and equipment (FF&E) might have a DCV that ranges from 30% to 70%.
While the lender may give you the DCV, you can also estimate that value before applying for a loan by knowing the collateral value, also known as the fair market value (FMV), and the discount percentage set by the lender. To calculate the DCV, use the following formula:
Alternatively, the lender may give you the maximum CCR for your potential loan based on the collateral type. In this case, you need to calculate what the DCV will need to be to get loan approval. Use this formula:
Total Loan Amount
If you’re preparing to obtain financing, the total loan amount represents the total amount borrowed. Meaning, your total current principal loan balance. This excludes interest payments, however.
For example, if you take out a loan for $100,000 and pay off $10,000 in principal and $2,000 in interest in the first year, your total loan amount at the end of the year is $90,000.
You can calculate the maximum total loan amount the lender will approve based on the DCV and the CCR required for approval. To calculate the total loan amount, use the following formula:
| Total Loan Amount | = | Discounted Collateral Value |
| Collateral Coverage Ratio |
Collateral Coverage Ratio Examples
Various scenarios have different types of calculations that can be involved with CCR. See below for some additional examples.
Discounted Collateral Value | $50,000 |
Total Loan Amount | $25,000 |
Collateral Coverage Ratio | ($50,000 ÷ $25,000) = 2.0 |
This example demonstrates a simple CCR calculation. It represents a loan amount of $25,000, with a DCV of $50,000. By dividing the DCV by the total loan amount, we get a CCR value of 2.0. Essentially, this allows for two times the coverage of the loan amount. This should be a satisfactory CCR for the lender, pending other loan qualifications are met.
Collateral Value = $100,000 | Discount Collateral Value |
|---|---|
Discount Percentage of 80% | ($100,000 × 80%) = $80,000 |
Discount Percentage of 60% | ($100,000 × 60%) = $60,000 |
Discount Percentage of 30% | ($100,000 × 30%) = $30,000 |
In this example, you’ve valued your collateral at $100,000. To determine the DCV, you multiply the collateral value by the discount percentage. The DCV will vary depending on the discount percentage given by the lender, which depends on the collateral type and condition.
Lender Required CCR = 1.5 | Discount Collateral Value |
|---|---|
Loan amount of $50,000 | ($50,000 × 1.5) = $75,000 |
Loan amount of $100,000 | ($100,000 × 1.5) = $150,000 |
Loan amount of $200,000 | ($200,000 × 1.5) = $300,000 |
For this example, we assume that the lender requires a CCR of at least 1.5. To ensure the collateral offered covers the requested loan amount, we can calculate the required DCV by multiplying the potential loan amount by the required CCR.
Lender Required CCR = 1.5 | Maximum Loan Amount |
|---|---|
DCV of $75,000 | ($75,000 ÷ 1.5) = $50,000 |
DCV of $150,000 | ($150,000 ÷ 1.5) = $100,000 |
DCV of $300,000 | ($300,000 ÷ 1.5) = $200,000 |
In this last example, we can determine the maximum loan amount available based on dividing the known DCV by the lender-required CCR.
Why Is the Collateral Coverage Ratio Important?
The CCR plays an important role in the lending process, as lenders and creditors can use this calculation to determine the maximum loan amount available to a borrower, along with the minimum required collateral. This helps mitigate risk by ensuring that there’s enough collateral to cover the loan in case of default. Essentially, the higher the collateral ratio, the less risk for lenders.
Most lenders have a minimum CCR of 1.0 for prime borrowers and will increase the CCR requirement depending on a borrower’s credit, the industry the borrower is in, and a borrower’s overall debt exposure. A borrower in an industry with a history of higher loan defaults or a borrower with a marginal credit score may warrant a CCR closer to 1.5 or 1.6.
Borrowers with ratios below the bank’s guideline will need either additional assets to secure a loan, to take action to increase their collateral ratio, or to apply for an SBA loan that features the SBA’s guarantee in case of borrower default.
Increasing Your Collateral Ratio
Collateral can increase your chances of getting a small business loan since it helps reduce risk to the lender in the event of loan default. In this instance, the lender can seize and sell off the pledged collateral to recoup any financial losses. That being said, the higher the CCR you have, the better your odds of approval. If your collateral ratio is low, however, it might be difficult for you to get financed for the amount you need.
The following are ways to increase your collateral ratio:
- Pledge higher value assets as collateral: In general, the higher the value of the collateral, the more flexible borrowing power you have. For example, if you’re looking for $30,000 in financing and have a purchase order for $100,000 and outstanding invoices totaling $50,000 as available assets, purchase order financing may be an option due to its higher value.
- Pledge assets with lower discount rates: Lenders may be flexible with their DCV requirements, and it’s worth talking to your lender to find out how much they will discount your assets. Use the assets that have a lower discount rate, such as real estate, to help increase your coverage ratio.
- Collateralize multiple assets: Many lenders will place a blanket lien on your assets and blend the discounted values to help boost your coverage ratio and provide you with a larger sum of available funds to borrow.
Frequently Asked Questions (FAQs)
CCR is a calculation that evaluates the discounted value of collateral and its ability to ensure coverage of a loan. It can provide details such as maximum loan limit eligibility and is commonly used by lenders to determine risk as part of the lending process.
To calculate collateral coverage ratio, you divide the discounted collateral value by the total loan amount. Simply put, it’s: Collateral Coverage Ratio = Discounted Collateral Value ÷ Total Loan Amount.
Essentially, collateral coverage is what secures a loan when obtaining financing. A lender often requires some form of collateral as part of a loan agreement to help mitigate risk in the event of loan default and recoup any financial losses on their end.
Bottom Line
Calculating the collateral ratio can allow a lender to determine the maximum loan amount available to a borrower and ensure enough collateral is available to secure the loan. The CCR is calculated by dividing the DCV by the total loan amount. Keep in mind that the discount rate varies by the type of asset that’s being collateralized, and lenders typically want a CCR of at least 1.0 to give them a buffer in case of default. The higher a CCR is, the lower the risk to the lender and the more likely your loan will be approved.
