Four Steps to Understanding Unsecured Business Loans
April 4, 2019
April 4, 2019
Many people think of loans in the most traditional sense: Money is needed for a large purchase like a home or a car, and banks provide loans to people and businesses to buy those big-ticket items. The money goes directly towards that purchase and repayment is tied directly to the item or property. On the flip side, many lenders offer what are known as unsecured business loans (personal loans, too), which donâ€™t always require a specific purpose and donâ€™t always require much more than a great credit history to obtain.
There are risks involved, and unsecured loans wonâ€™t work for every business, so letâ€™s take a look at unsecured business loans and how they work.
When most businesses apply for and receive a loan, the funds they get are secured by an object being purchased, money in the bank, or other assets owned by the business getting the loan. If the purpose of the funds is to purchase a piece of equipment or a building, the collateral is fairly straightforward and is usually the â€śthingâ€ť being purchased. Things get a bit cloudier when more complex items are purchased, or when the loan is being used for something like a business expansion. In these cases, banks and other lenders may require the business owner to sign over other property or cash as collateral to secure the loan.
As the name suggests, unsecured loans do not explicitly require collateral like this. These loans are based solely on the creditworthiness of the business, the business owner, and any partners involved in the operation. This may mean that the borrower can receive loan funding with not much more than a signature (hence the synonymous term signature loan). Unsecured business loans can place an extremely high burden of risk on the lender, because they have no direct way to recover their money should the borrower default on the loan.
Despite offering what is being called an unsecured loan, lenders may end up placing a blanket lien on other business assets or may require a personal guarantee from the business owner to help ensure the loanâ€™s repayment in full.
The actual process of applying for an unsecured business loan is nearly identical to one that requires collateral, obviously missing the step where the bank collects information on the assets being used to secure the loan. The biggest differences in the application process are related to the borrower and how the lender views the borrowerâ€™s credit history.
General requirements from a collection of online and traditional lenders includes:
In some cases, a business owner may have a particularly strong relationship with their banker and can establish a level of trust that may help overcome a shortfall in one or more of the areas above, but the general rule is that unsecured loans require a near-spotless credit history.
Unsecured business loans are not only different than secured loans in the application process, they hold several advantages over traditional business loans:
Unsecured business loans wonâ€™t be the best choice for every company, and may be a more expensive, riskier option overall. Some of the downsides include:
Whether or not an unsecured business loan is right for your needs will depend on the factors listed in this article and many others. Some will find that unsecured business loan pricing and the risks involved outweigh the benefit of not needing collateral. New businesses in particular can benefit from the more flexible use of funds and shorter approval times, but more established companies may find that the more traditional funding route provides them with the best path forward. Understanding your needs and goals will help you make the best choice, and like anything else in the financial world research and an open mind are the most effective tools.