Loan for Business

Collateral Security vs Primary Security

Q: How do banks decide between primary and collateral security while sanctioning a loan?

Banks evaluate loan amount, primary security meaning , borrower risk, cash flows, and decide if primary security vs collateral security is required.

By Tata Capital
29 December 2025
10 mins read
3328

As a business owner, you might already be aware of the concept of security when applying for a business loan. The financial institution where you submit your loan application asks you to provide a guarantee of repayment. This guarantee is called security.

Did you know there are two types of loan security, primary security and collateral security, and these terms are not interchangeable? Understanding loan security and its types will help you organise your resources better when taking a business loan. Let’s take a deep dive into the world of loan security and its two types, primary security and collateral security, to understand their importance and critical differences.

What is security?

When you take out a loan from a financial institution, you provide a tangible asset as security. This tangible asset (e.g., a house or a car) ensures that the lender is financially covered if you are unable to repay the loan. Security then secures the lender’s financial interests and incentivises you to repay the loan on time.

The loans which require security are called secured loans. Examples of secured loans include home loans, vehicle loans, etc. Unsecured loans, like some types of personal loans, do not require any security. You can typically avail of secured loans at much lower interest rates compared to loans that are unsecured. This is because, with security, the lender is assured of getting their money back in case of adverse circumstances.

Security serves two purposes in a loan. First, it ensures that the lender’s rights are safeguarded in case of a loan default or other adverse conditions. Second, it also acts as a deterrent for the borrower against loan default.

What is primary security?

Primary security is your asset, which is directly associated with the loan. If you are unable to pay back the loan, this asset will be first considered by the lender to recover their money. Some common examples of primary security are the assets for which you take the loan, like a car for a car loan or a house for a home loan, etc.

Some characteristics of primary security are as follows:

1. Direct relation to loan:

Primary security is the asset or project for which you take the loan. Hence, primary security is directly tied to the loan in this respect.

2. Source of repayment:

If you default, the assets you pledge as primary security are the primary source of loan repayment.

3. Specific form:

Usually, the assets you put up as primary security will be agreed upon by you and the lender when signing the loan agreement.

4. Tangible protection against default:

Primary security is a tangible asset for protection against loan default.

What is collateral security?

Now, let’s talk about collateral security. Collateral security, as the name suggests, is additional protection that you offer to the lender if the primary security is insufficient to cover the entire loan amount. Collateral security can take various forms and is not directly tied to the loan. Let’s understand this with the help of an example.

Suppose you own a process line and want to add a new machine to your production plant. You approach the lender for a loan. In this case, the machine will become the primary security. If the lender demands additional security, say you put up your company stocks, which become collateral security.

Some characteristics of collateral security include:

1. Supplementary protection:

In case of loan default, the financial institution will try to recover their money first by using the primary security. Collateral security comes into the picture only when the primary security turns out to be insufficient.

2. Diverse forms:

Collateral security can take many forms, like property, stock options, bonds, vehicles, jewellery, etc.

3. Increased chance of approval:

By providing collateral security, you can increase your chances of loan approval as it provides additional risk mitigation for the lender. To elaborate further, collateral security is like a buffer for the lender. The larger the buffer, the higher the lender’s risk mitigation and the higher the chance of loan approval.

4. Loan and risk specific:

For a particular loan, the collateral security will be decided by the type of loan and your perceived ability to repay it by the lender. Additionally, some types of loans, like micro-credit or instant loans, do not require any collateral.

Why is collateral security important for business loans?

Understanding how lenders assess risk begins with clarity on primary security meaning and how it differs from additional safeguards.

In simple terms, primary security vs collateral security explains what directly finances the loan versus what backs it up if repayment fails:

Clarifies risk coverage: Primary security meaning refers to the asset created or purchased using the loan, while collateral security offers additional protection beyond the primary security.

Strengthens lender confidence: The combination of primary security vs collateral security reassures lenders that multiple layers of protection exist.

Improves loan eligibility: Businesses offering collateral security often find it easier to qualify, especially when primary security alone is insufficient.

Supports higher loan limits: Collateral security allows lenders to sanction larger amounts than what primary security value alone permits.

Leads to favourable terms: Loans backed by collateral often come with better interest rates and repayment flexibility.

Helps startups and MSMEs: For businesses with limited credit history, collateral bridges the gap where primary security value may be low.

Encourages responsible borrowing: When assets are pledged, businesses tend to plan cash flow and repayments more carefully.

Expands funding options: Understanding primary security vs collateral security helps borrowers choose suitable loan products confidently.

Types of assets accepted as collateral security vs Primary security

To understand lender requirements, it’s important to know the distinction between primary security vs collateral security and the primary security meaning in business loans.

In simple terms, what is collateral security refers to additional assets pledged to reduce lender risk, while primary security is directly linked to the loan purpose:

Stock and inventory: Under primary security meaning, raw materials, finished goods, or work-in-progress funded by the loan are treated as primary security.

Plant and machinery: Equipment purchased using loan proceeds qualifies as primary security, as it directly supports business operations.

Receivables and book debts: Outstanding invoices generated from business activity are often accepted as primary security by lenders.

Commercial property: Owned shops, offices, or warehouses provide strong asset backing.

Residential property: Homes or land owned by the borrower or guarantor commonly serve as collateral security.

Fixed deposits and bank deposits: These liquid assets are frequently accepted as collateral security due to their stable value.

Gold and marketable securities: Gold ornaments, bonds, or shares may be pledged as collateral security depending on lender policies.

Personal guarantees: While not physical assets, guarantees often supplement primary security vs collateral security structures.

Understanding which assets qualify helps businesses plan financing more effectively and approach lenders with clarity and confidence.

Differences between primary security and collateral security

1. Priority of repayment

In case of loan default, the priority is given to the primary security to recover the loan amount. If the primary security is insufficient to recover the entire amount, the lender considers collateral security for loan satisfaction.

2. Relationship to the loan

Next on the list of primary security vs. collateral security is the relationship to the loan. Primary security is the financial asset directly linked to the loan. Collateral security is indirectly linked to the loan and provides additional assurance.

3. Liquidation at the time of default

Primary security and collateral security differ in liquidation at the time of loan default. As soon as a loan defaults, the primary asset is immediately sold off or liquified to recover the loan amount. If the entire loan amount is not recovered, the lender then liquefies the collateral security.

4. Legal implication and creditor’s rights

If the borrower declares bankruptcy or defaults on a loan, the primary security is given legal precedence to safeguard the creditors’ rights. Compared to this, collateral security is a lower priority for ensuring creditor’s rights in case of default situations.

When do lenders require collateral security in addition to primary security?

To assess lending risk, banks evaluate primary security meaning and decide whether extra protection is needed. While primary security covers assets created through the loan, understanding primary security vs collateral security explains why lenders may ask for more.

Here’s when what is collateral security becomes relevant:

High loan amounts: When the loan size exceeds the value of primary security, lenders seek collateral security to bridge the risk gap.

New or early-stage businesses: Startups often lack strong assets, so collateral security supports loan approval.

Limited credit history: Borrowers with thin or inconsistent credit profiles may need collateral in addition to primary security.

Unstable cash flows: Seasonal or cyclical businesses pose higher repayment risk, prompting lenders to demand collateral security.

Unsecured loan conversion: When borrowers seek better terms on an existing loan, lenders may introduce collateral.

Longer repayment tenures: Extended tenures increase uncertainty, making collateral security necessary.

Industry risk factors: Businesses in volatile sectors often require additional security beyond primary assets.

Weak financial ratios: Low profitability or high leverage may trigger collateral requirements.

Regulatory or internal policies: Some lenders mandate collateral security above specific thresholds.

Examples illustrating primary security and collateral security

Understanding primary security meaning becomes easier with practical examples that clearly show primary security vs collateral security and explain what is collateral security in real situations:

Machinery purchase loan: A manufacturing unit takes a loan to buy equipment. The machinery itself is the primary security, as it is created from the loan. If the lender also takes the factory land as backup, that land is collateral security.

Working capital loan: A trader borrows funds to manage inventory. The stock and receivables financed by the loan form the primary security. If the business owner pledges a residential property, it becomes collateral security.

Vehicle loan for logistics: A transport business buys delivery vehicles using loan funds. The vehicles act as primary security. Any fixed deposit pledged separately is collateral security.

Startup term loan: A startup uses funds to build operational assets. These assets represent primary security. Since risk is higher, the promoter’s personal property explains what is collateral security.

Primary security vs collateral security: Checklist before applying for a loan

Before applying for a business loan, understanding primary security vs collateral security from a lender’s perspective helps you prepare assets correctly. This checklist clarifies what is collateral security and what you should assess in advance:

Identify the primary asset: Confirm which asset will be created or purchased using the loan and qualifies as primary security.

Check asset ownership: Ensure ownership documents for both primary and collateral assets are clear and up to date.

Assess asset value: Compare the loan amount with the value of primary security to see if additional collateral may be required.

Prepare backup assets: List properties, deposits, or other assets that can serve as collateral security if needed.

Review lender policies: Some lenders mandate collateral beyond a certain loan size or risk category.

Evaluate repayment capacity: Strong cash flows can reduce reliance on collateral security.

Understand legal implications: Know the risks involved when pledging personal or business assets.

Concluding thoughts

We hope that now you completely understand primary security and collateral security and their differences. Both primary and collateral security increase risk mitigation for lenders and act as effective deterrents against default.

If you’re a business owner looking for a business loan to expand your business, you might be hesitant to put your personal or professional assets on the line. Keep your assets safe, and consider Tata Capital’s collateral-free business loans.

Tata Capital offers business loans for women with low processing charges and multiple EMI options. So, choose Tata Capital for a business loan, apply and grow your business without worrying about your assets.

FAQs

What is collateral security with example in a business loan?

What is collateral security refers to an additional asset pledged to secure a loan. Example: a business owner offers personal property as backup beyond the loan-funded business asset.

What is the difference between primary security and collateral security?

Primary security vs collateral security means the loan-created asset is primary security, while any extra asset pledged separately is collateral security.

Is it mandatory to give collateral security for all business loans?

No. Collateral is not mandatory for all loans. Many small or scheme-based loans rely only on primary security or are fully unsecured.

What is primary security meaning in secured loans?

Primary security meaning is the main asset purchased or created using loan funds, such as machinery, inventory, or vehicles.

How do banks decide between primary and collateral security while sanctioning a loan?

Banks evaluate loan amount, primary security meaning, borrower risk, cash flows, and decide if primary security vs collateral security is required.

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