There are few circumstances in which it makes sense for an investor to lend money using art as collateral. The art world is complex, and even with the right art advisor at your side, it can be difficult to fully understand the market value of the collection in question. Large firms such as Sotheby’s offer short-term loans to collectors using art as collateral, but they rely on a wide base of market knowledge to protect themselves. Citigroup offers loans using art as collateral through its private bank, but its customers have significant liquid assets in addition to their art collections.

When lending money against an art collection, the first step is to obtain a fair-market value appraisal. Instead of contacting the art dealer who originally sold the art, seek an independent appraiser with proven credentials in the field. If you proceed, lend no more than 50 percent of the total value of the collection. Bear in mind that in the event of a default and liquidation, transaction costs can be high—as much as 20 percent in the case of auction houses, sometimes more when selling through private dealers. And if the collection does not sell at once, storage fees may accrue. Theses hidden costs are often enough to discourage private investors from involvement with loans using art as collateral.

Wendy Cromwell, Cromwell Art, New York

Art lending is common, but is a skilled process involving relatively high risk. The most difficult thing to establish is the value of a piece. The insurance (or full retail replacement cost) value is naturally higher than the mid-auction estimate. Art loans would normally be up to 50 percent of this lower valuation, and the valuation would be from an obviously independent and expert valuer.

At the same time, the art itself would need to be liquid, so if the lender did keep it, there would be a market where he could sell and realize cash to satisfy the debt. The art must be properly insured. Finally, lenders have encountered problems in which clients have disappeared with both the loan and their art; this is a risk that insurers will not normally cover.

Charles Dupplin, fine art and private client division, Hiscox, London

Unless you want to own the art, don’t lend money if you aren’t confident that you will be repaid. Should the loan go bad and it’s not art you want for your collection, you should be prepared to sell or donate it. For these purposes, you must be assured prior to lending the money that the works are internationally marketable and desirable in the current marketplace. You should also obtain a reputable appraisal from one of the major auction houses supporting the amount you are lending (the standard loan-to-value ratio is 50 percent).

When properly structured, art loans allow the borrower to gain liquidity from a traditionally illiquid asset without having to sell the art, and give the lender an opportunity to offer a unique, low-risk lending solution.

Suzanne Gyorgy, art finance director, Citigroup Private Bank, New York

In this case, using art as collateral for loans would not seem to be a sound business decision. If the person wanting to borrow the money is a friend or colleague, it could strain the relationship if any of the variable risks, such as a default, were to occur. It would be difficult to have the collection accurately appraised and evaluated, and insuring the art could be complicated. Also, the art market or the particular genre could suffer a big correction. If you had no desire to keep the artwork, it would have to be sold at substantial discounts.

There are times when such a move might be considered, however. If:

• The lender is in the business of buying/selling art and knows the art market.

• The lender is experienced in loaning money against tangible assets, such as art, for high returns.

• The lender would not need to liquidate if the loan defaulted and could wait for the right opportunity to sell.

• The lender feels the risk is worth the return and the possibility of owning the art collection.

Julie Cline, Julie Cline Fine Arts Advisory Service, Santa Barbara, Calif.