Small business loans can be secured or unsecured depending on the loan you’re applying for. In a nutshell, secured business loans are backed by collateral, while unsecured loans aren’t. Each option has its risks and merits, but it can be difficult to decide which type is the best.
This blog post will discuss the difference between secured and unsecured loans so you can make an informed decision for yourself and your business.
A small business loan can be secured or unsecured depending on the loan you’re after. A secured small business loan is backed by collateral, while secured loans aren’t.
You can use your business or personal assets to get a secured loan. Some of the most common examples are real estate, accounts receivable, equipment and machinery, vehicles, investments, insurance policies, and bank accounts.
Unsecured loans are a great option if you don’t have assets to pledge or you need fast access to capital. On the other hand, choose secured loans if you want better terms, or you’re a new business without any credit history.
What is an Unsecured Small Business Loan?
An unsecured business loan is a loan that doesn’t require any collateral against the amount you’re borrowing, so it’s solely based on your creditworthiness.
Small businesses often apply for an unsecured loan when they do not qualify for traditional loans or can’t have better terms. These loans tend to be favorable towards the borrower, so lenders typically charge higher interest rates for unsecured loans than those backed by collateral. Repayment terms are also shorter to reduce the risk lenders take on. To qualify for an unsecured loan, you need to show lenders a good credit rating, cash flow forecast, and financial history. Keep in mind that defaulting on an unsecured business loan can have long-term effects on your business’ credit score.
It’s rare for banks and other traditional lenders to approve unsecured loans since they prefer to write loans based on asset value. You can usually get these loan agreements from alternative or online lenders.
What is a Secured Business Loan?
A secured business loan requires collateral, such as commercial property, equipment, or other valuable assets lenders can claim if you fail to repay the loan. The money you can borrow is based on the loan-to-value (LTV) ratio your lender offers. For example, if your asset is worth $100,000 and the lender provides an 85% LTV ratio, you’ll get up to $85,000.
Most small business owners use business assets as collateral, but it’s also possible to put up your personal assets. Here are some of the most common assets entrepreneurs use:
Machinery and equipment
And any other assets that lenders deem valuable.
Secure business loans have lower interest rates than unsecured ones because the collateral guarantees they’ll get their money back. They can recoup their losses by selling your assets in case you default.
If your collateral depreciates, you may be asked to pledge additional assets to keep your secured loan agreement. You’re also responsible for shouldering the difference if your lender seizes your assets and sells them for less than what you owe.
Pros and Cons of Secured Business Loans
Lower interest rates: These loans typically have lower interest rates than unsecured loans because the lender has the security of an asset as collateral.
Flexibility: You can use the loans for different purposes, like financing working capital, purchasing new equipment, and expanding operations.
Easier to qualify: It’s easier to qualify for secured business loans because the lender has collateral to fall back on in case of a default.
Longer repayment terms: Secured loans offer longer repayment terms, making repayments more manageable for a small business owner.
Higher loan amounts: It’s possible to qualify for higher loan amounts based on the value of your collateral.
Requires collateral: Some business owners don’t have any collateral to pledge or don’t want to risk losing their assets. If this is the case, an unsecured business loan may be a better option.
Risk of losing your assets: Lenders will seize your assets if you cannot repay the loan. Your business could suffer a significant financial loss if this happens.
Limited availability: Secured loans are only available for business owners who can provide collateral.
Extra fees: Lenders often require a trusted professional to appraise the collateral you plan to pledge. They prefer to work with their own appraisers, so they will usually charge an appraisal fee.
Prolonged underwriting process: Traditional lenders often take more than a week to approve a secured loan application. If you’re looking for same-day business loans or fast loans, you can apply from alternative lenders like SMB Compass.
Lenders have rights over collateral: You may not be able to use the pledged collateral since lenders have the rights over them until you pay off the loan.
Pros and Cons of Unsecured Business Loans
No collateral required: Unsecured business loans do not require any collateral, so businesses do not have to risk assets to obtain the loan.
Faster approval process: Because there is no need to evaluate collateral, the approval process for unsecured loans can be faster than for secured loans.
More options: Unsecured loans are available from a variety of sources, such as banks, credit unions, and online lenders, providing more options for businesses.
More accessible to small businesses: Unsecured small business loans may be more accessible to small businesses that may not have significant assets to use as collateral.
Higher interest rates: Unsecured loans typically have higher interest rates than secured ones because the lender does not have collateral security.
Shorter repayment period: Unsecured loans often have shorter repayment terms than secured loans, making the payments more challenging to manage.
More difficult to qualify: Because there is no collateral to fall back on, it may be more difficult to qualify for an unsecured loan.
Higher credit score requirement: Unsecured small business loans typically have higher credit score requirements than secured loans, which may limit the options for some businesses.
Limited loan amount: Unsecured loans often have a lower loan amount than secured loans, which may not be enough for some businesses.
Which Loan is Right for Your Business?
No type of loan is better than the other. It ultimately depends on your business’s unique financial needs and goals. Here are a few examples.
When to Choose an Unsecured Business Loan
You need to secure funds quickly or prefer short-term financing.
Unsecured business loans offer quick access to funds, making them a great option if you need money for immediate expenses. However, the trade-off is that unsecured loans have smaller loan amounts and higher interest rates than secured loans.
You don’t have collateral or don’t want to put your assets at risk.
Unsecured loans are also a great option if you don’t have collateral or don’t want to risk losing your assets. However, most lenders may still require a personal guarantee, a UCC lien to qualify for the loan, or some other form of security.
When to Choose a Secured Business Loan
You’re a startup or don’t have a good credit rating.
Pledging your assets makes qualifying for small business loans easier if you’re a new business or have a bad rating. But some banks and traditional lenders may still require excellent credit and a couple of years in business to get a loan from them.
You want more favorable loan terms.
Providing collateral can get you larger loan amounts, longer repayment terms, and lower interest rates compared to unsecured small business loans.
Conclusion: Is a Small Business Loan Secured or Unsecured?
When selecting a loan for your business, it's essential to determine which option meets your company's unique needs.
Secured loans offer new businesses an opportunity to fund operational costs, but you put your assets on the line in exchange. Unsecured loans are often best suited for those who have established credit or qualify based on other criteria that meet lender requirements - without the need to list your property as collateral.
Carefully weigh both loan options before deciding which is suitable for you and your business venture!