Overcollateralization

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Overcollateralization

The practice or process of placing an asset as collateral on a loan where the value of the asset exceeds the value of the loan. For example, a person could pledge a farm (worth $10 million) on a loan for $5 million. Usually, however, the value of the asset only exceeds the value of the loan by 10-20%. Overcollateralization reduces the risk for the lender and improves the borrower's creditworthiness. It is used most commonly when a bond issuer wishes to improve its credit rating.
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If things don't go as planned and you're not able to pay off the loan "as agreed," or if your firm is growing rapidly and the bank decides not to continue funding that growth, you have put your firm at financial risk by over-collateralizing the loan.