Collateral Value: Definition, How It's Used, and LTV Ratios

What Is Collateral Value?

The term collateral value refers to the fair market value of the assets used to secure a loan. Collateral value is typically determined by looking at the recent sale prices of similar assets or having the asset appraised by a qualified expert.

Understanding Collateral Value

Collateral value is one of the key aspects considered by lenders when reviewing applications for secured loans. In a secured loan, the lender has the right to obtain ownership of a particular asset—called the "collateral" of the loan—if the borrower defaults on their obligation. In theory, the lender should recover all or most of their investment by selling the collateral. Therefore, estimating the value of that collateral is a key step before any secured loan is approved.

The advance rate is used to value a collateral asset used to secure a loan. Such assets usually include real estate, motorized vehicles, and investment and insurance accounts.

Home Mortgage and Collateral Value

Secured loans can be made against all types of property. One of the most common types of secured loans is the home mortgage, in which the house is given as collateral to secure the mortgage loan. In this situation, if the borrower fails to make their mortgage payments, the mortgage lender can sell the house to recuperate their investment.

Meanwhile, the collateral value of the house is typically determined by relying on an appraiser who specializes in real estate. Other valuation metrics, such as recent tax assessments or comparable transactions, may also be consulted.

Example of Collateral Value

Depending on the type of asset being used as collateral, the collateral value methods may differ. For instance, if a loan is secured by publicly-traded stock, then the current market price of those securities can be used when estimating its collateral value. 

In other cases, the collateral being used may be rarely traded on the market. For instance, a borrower might pledge collateral in the form of privately held shares or alternative assets, such as fine art or rare collector's items. In these situations, an appraiser may need to use specialized valuation methods, such as calculating the value of the private shares by using discounted cash-flow analysis (DCF). Meanwhile, fine art and other rare items may need to be appraised by specialists who are familiar with the private collector and auction markets for those types of assets.

Special Considerations

Typically, the size of the loan provided by a lender—known as the borrowing base—will range from 70 to 90% of its collateral value. For instance, in the case of mortgage loans, lenders have traditionally offered 80% financing, which means that the borrower will need to provide a 20% down payment. However, the loan's exact size will depend on several factors, such as the perceived reliability of its collateral value, the current state of the market, and the borrower's credit rating.