Collateral Coverage Ratio: What It Is & How To Calculate It
This article is part of a larger series on Business Financing.
Many small business loans are secured by collateral, such as property or equipment, to provide security to a lender in case a borrower is unable to repay. The collateral coverage ratio (CCR) is used by lenders to set maximum loan limits on a borrower, comparing the collateral’s discounted value to the amount borrowed.
Most lenders use 1.0 as a minimum acceptable CCR but will increase this ratio based on borrower risk and their credit. Learn more about how CCR is computed below.
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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 a lender determines a maximum borrowing limit, it will discount the collateral the loan is securing. This builds in the potential for a decline in value through normal use, changes in property values, and collection costs in case a borrower defaults.
Lenders normally require that a loan can’t be more than the discounted value of the underlying collateral. These discounted rates will vary based on the potential for decline in value.
Real estate often has a DCV of 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:
Discounted Collateral Value = Collateral Value x Discount Percentage
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:
Discounted Collateral Value = Collateral Coverage Ratio x Total Loan Amount
Total Loan Amount
The total loan amount represents your total current principal loan balance, excluding interest payments. For example, if you take out a loan for $100,000 and you 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.
If you are preparing to take out a loan, the total loan amount is the total amount borrowed.
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
In this section, you will see the different calculations that can be involved with the CCR. Click on each header below to see the sample.
Discounted Collateral Value | $50,000 |
Total Loan Amount | $25,000 |
Collateral Coverage Ratio | ($50,000/$25,000) = 2.0 |
In this example, you want to take out a loan of $25,000 on collateral that has been discounted to $50,000. Your CCR is 2.0. This should be a satisfactory CCR for the lender, pending other loan qualifications are met.
When to use: When you know the DCV and the total loan amount, and you want to calculate what the CCR is to determine whether your loan amount is within the approval range of the lender.
Collateral Value = $100,000 | Discount Collateral Value |
|---|---|
Discount Percentage of 80% | ($100,000 x 80%) = $80,000 |
Discount Percentage of 60% | ($100,000 x 60%) = $60,000 |
Discount Percentage of 30% | ($100,000 x 30%) = $30,000 |
You have determined that the value of your collateral is $100,000. The DCV will vary depending on the discount percentage given by the lender, which depends on the collateral type and condition.
When to use: When you know the collateral value and the discount percentage set by the lender for that particular type and condition of collateral, and you want to know the DCV. You can now take the DCV value and pair it with a total loan amount to get the CCR as in example 1, or you can use it with a lender-required CCR to determine the maximum loan amount as in example 4.
Lender Required CCR = 1.5 | Discount Collateral Value |
|---|---|
Loan Amount of $50,000 | ($50,000 x 1.5) = $75,000 |
Loan Amount of $100,000 | ($100,000 x 1.5) = $150,000 |
Loan Amount of $200,000 | ($200,000 x 1.5) = $300,000 |
In this scenario, you know the lender requires a CCR of at least 1.5. To determine what the discount collateral value of each loan must be, you can multiply the CCR by the potential loan amount.
When to use: When you know the lender-required CCR and the loan amount you wish to receive. This will allow you to determine the DCV required to qualify for the specific loan amount you need.
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, you can calculate the maximum loan amount you can apply for based on the DCV and the CCR, as given by the lender for that particular loan type.
When to use: When you know the lender-required CCR and the DCV. You can calculate the maximum loan amount you can receive within those lender-set limits.
Collateral Coverage Ratio Calculator
You can use this calculator to determine the CCR when you have the collateral value, discounted collateral percentage, and loan amount. If you have the DCV from the lender instead, you can enter that number as the collateral value and 100% for the collateral percentage.
Why Is the Collateral Coverage Ratio Important?
The CCR is important because lenders and creditors use it to determine maximum loan amounts and minimum required asset collateral. This ratio reduces their risk by ensuring there’s enough collateral to cover the loan in case of default. 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 either need additional assets to secure a loan or apply for a Small Business Administration (SBA) loan that features the SBA’s guarantee in case of borrower default.
Before applying for a loan, check out our guide on small business loan requirements for additional factors to consider.
Increasing Your Collateral Ratio
Collateral helps your chances of getting approved for a loan because it reduces lender risk in case of default as you have pledged assets that can help repay the defaulted loan. 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: 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 to consider due to its higher value.
- Pledge assets with lower discount rates: Talk to your lender and 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: We touched on this earlier in the article. Many lenders will place a blanket lien on your assets and blend the discounted values to help boost your coverage ratio and provide you a larger sum of available funds to borrow.
Bottom Line
The CCR calculates the percentage of your loan secured by a discounted asset. That discount rate varies by the type of asset that’s being collateralized, with real estate getting the lowest discount rate. 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.
