August 19, 2022 | Last Updated on: August 30, 2024
Secured versus unsecured small business loans: Which is the right type for your business?
It’s a question business owners seeking financing have to grapple with.
This article explains the pros and cons of both types of loans and what they can be used for. You will come away with everything you need to know to find the right loan for you.
There are two basic types of loans that every business owner should know about before getting financing: secured and unsecured loans.
Whether you’re looking to get a loan from a traditional bank, online lender, or one backed by the U.S. Small Business Administration (SBA), it’s essential to know what you’re getting into when signing up for a secured or unsecured loan. The primary difference is who is taking the more significant risk on the loan, the borrower or the lender. An unsecured loan places greater risk on the lender; a secured one on the borrower. In some cases, the business owner could lose critical equipment or property or put their personal finances at risk with an unsecured loan.
By taking the time to learn more about loans, you are better able to determine not just the best loan options for you but also whether you’re willing to absorb the risk of getting financing.
Secured loans are backed by some type of collateral. Collateral is something pledged to pay back the loan if monthly payments are unable to be made. If you can’t repay your loan, your lender may take the collateral. This makes the loans riskier to business owners than no collateral loans because you put up valuable property you could lose.
Collateral for a secured loan can be something you’re purchasing, such as business property or equipment. It’s similar to when you take out a mortgage to buy a house. The bank keeps the deed to your home until you pay it back, including interest and fees. If you are unable to make your mortgage payments, the bank can put a lien on your house and could sell it out from you.
The concern about losing valuable personal or business property make it more likely loans will be paid back. That’s why lenders are usually willing to make higher-value loans if they’re backed by collateral.
Collateral can also include things like a home, valuable work of art or jewelry, vehicle, or securities. These types of personal assets are often referred to as a personal guarantee. It needs to be something of value the bank can take and sell if the loan is defaulted on.
If you are a few days late on your loan payment, the lending company will not immediately seize your assets. However, if you continue missing payments and violating the loan terms, the lender may exercise its legal right to issue a lien.
In almost all cases, if you’re seeking a substantial amount of financing, secured loans will be your only option.
Here are some types of loans that are typically secured funding options:
An unsecured loan is issued based exclusively on the borrower’s creditworthiness instead of collateral.
Banks, online lenders, and alternative financing companies offer unsecured loans. Typically these loans are for limited amounts of money. It’s challenging to get approved for these loans unless you have a solid credit score, long history in business, and a reliable income stream.
Getting approved for unsecured loans with a bad credit score can be extremely difficult. New businesses or startups founded by entrepreneurs typically don’t qualify.
Because the unsecured loan business loan is backed by an agreement rather than collateral, loan terms will reflect the risk the financing company is absorbing. You can expect relatively high-interest rates and shorter repayment periods on unsecured loans.
Here are some examples of unsecured financing options:
Collateral is something that is pledged as security for repayment of a loan. The financing company can sell it if several loan payments are missed. (Specifics are outlined in the loan agreement.) The purpose of collateral is to distribute risk more fairly. It helps ensure that the lender and lendee have a stake in the game. If you want to access large amounts of business capital, it will require some form of collateral, whether business or personal assets.
Lenders base unsecured loans on the current market value of the property or asset (collateral) minus the amount still owed on it.
Some common types of collateral that can be used to back business loans include:
There are good things and negative ones about secured loans.
Pros:
You will likely be able to find a loan for working capital and other business needs.
Cons:
The pros listed above are what you gain by putting up collateral. By placing your personal or business assetson the line, you can usually secure better annual percentage rates (APRs) and terms from your lender.
There are good things and negative ones about unsecured loans.
Pros:
Cons:
The primary issue with unsecured loans is personal financial risk. You don’t have to put up collateral, but you can be held personally responsible for the loan. That means that if you don’t repay the money, your lendercould sue you and come after your personal assets.
The type of loan you get depends on your business circumstances and what you need financing for.
A secured loan is typically easier to get approved for because it’s less risky for the lender. This is especially true if you have a poor credit history or no credit history. If that’s the case, lenders will want the loan backed with collateral to limit their risk.
Secured loans are issued in relatively large amounts and come with lower interest rates and longer repayment schedules. They’re typically used for larger business initiatives like buying a business property, purchasing machinery or equipment, expanding the business, or taking over another one.
Unsecured loans are generally short-term financing. Business owners are willing to take on higher interest rates and pay off the loan quickly because they have an immediate business need or unexpected financial situation, such as dealing with a cash flow emergency, purchasing inventory, making urgent repairs, and taking advantage of immediate opportunities.
In the end, you must do your due diligence to ensure you get the right loan from a reputable lender.
The loan application process for secured and unsecured loans for small business owners is similar. However, they have a few critical differences. In either case, the lender will check if you have good credit by reviewing your business and personal credit scores. The loan provider will request a credit report from one of the major credit reporting agencies.
In most cases, you will have to supply documents and other information to show that your business is healthy and financially stable. This could include the previous year’s tax returns, bank statements, profit and loss statements, revenue projections, and a business plan.
It is typically easier and faster to get approved at online and alternative lenders when compared with banks and traditional financial companies or for SBA loans. (In some cases loan money can be deposited in your business bank account in as little as one day.) However, the loans (even secured ones), come with relatively high interest rates and short terms.
In the end, if you consider the purpose of the loam, the loan amount, how much your can afford to pay back, how quickly you can pay it back, your credit score, and the stability of your business, you should be able to find the right secured or unsecured business financing for you.
Frequent searches leading to this page
business term loans, Term loans, business term loan, term loans for business
