Small business loans can either be secured or unsecured. The main difference between the two is that one requires you to use collateral as security for the loan and the other doesn’t.
Both loans offer benefits to small business owners, but whether you choose to take out a secured or unsecured loan affects the loan amount, interest rate, and repayment terms you’re going to get.
Keep reading to understand the advantages and drawbacks of the two types of business loans so you can make an informed decision about your financing.
What Is a Secured Business Loan?
A secured small business loan is a type of financing backed by collateral. The collateral can be in the form of business assets, such as real estate, vehicles, equipment, accounts receivable, or inventory.
Business owners may also pledge personal assets to secure a loan. Some common forms of collateral include the entrepreneur’s home, car, or financial assets like stocks and bonds.
With a secured loan, the borrower gives the lender a legal claim to whatever assets were used to collateralize a loan. This means if the borrower defaults on the loan, the lender can seize the assets as payment.
Collateral increases the risk of borrowing for business owners, but it decreases the risk for the lenders. That’s why secured loans typically have lower interest rates and longer repayment terms than unsecured loans. Lenders know that borrowers with assets on the line are likely to pay back their loans.
You can apply for secured business loans through traditional banks, credit unions, and online lenders. These types of loans come in different forms, including SBA loans, invoice factoring, business lines of credit, and equipment financing. Expand your search and compare loans and lenders to find the best solution available for your financing needs.
Business owners usually take out secured loans to keep up with demand or when they need to purchase more inventory or hire additional employees. Loans also help entrepreneurs buy new equipment to increase their production. Other times, small business owners may borrow capital to expand their operations to a second location.
Pros and Cons of Secured Business Loans
As with most financing options, there are benefits and disadvantages to secured business loans. Here are some things to consider:
- You can borrow higher loan amounts.
- Secured business loans provide access to lower interest rates.
- They may come with longer repayment terms.
- You have the flexibility to use personal or business assets as collateral.
- You won’t need a guarantor.
- They can be easier to qualify for.
- They offer a way for business owners with poor credit scores to borrow capital.
- You could lose your collateral if you miss payments.
- The application process takes longer because lenders may need to appraise the assets used for collateral.
What Is an Unsecured Business Loan?
An unsecured business loan doesn’t require borrowers to pledge an asset to secure the loan. This type of loan puts more risk on the lender. That’s why it may come with higher interest rates and shorter repayment periods.
Both traditional financial institutions and alternative lenders offer unsecured loans. Business owners looking to borrow unsecured loans are typically assessed based on their creditworthiness, time in business, and annual revenue. Online lenders have less strict eligibility requirements than traditional banks. For instance, online lenders may require a company to be in operation for a minimum of six months, while banks might ask for at least two years.
In an unsecured loan contract, lenders may ask business owners to sign a personal guarantee or a UCC lien to lessen their risk. When you sign a personal guarantee, you’re agreeing to be personally responsible for the debt if your company can’t pay. It also gives the lender the right to take possession of your personal assets as payment for the unpaid portion of the debt.
UCC stands for Uniform Commercial Code. It’s a legal document that a lender files to give notice that it has or might have an interest in the personal or business property of a borrower. UCC gives the lender a lien on the assets of a company, which essentially serves as collateral until the debt is paid.
Depending on the contract, the creditor may file a lien on specific collateral, or it may file a blanket lien. A blanket lien gives the lender the right to seize all business assets as payment in case the company defaults on the loan. So make sure you read your loan agreement and understand the terms before signing.
Pros and Cons of Unsecured Business Loans
Here are a few advantages and drawbacks of unsecured small business loans:
- The loan application process is typically easier and quicker than other types of financing.
- You don’t have to put up collateral to borrow capital.
- Your personal or business property isn’t at risk.
- You can borrow smaller loan amounts.
- They tend to have higher interest rates.
- They have shorter repayment terms.
- The maximum amounts available to borrow are lower compared to unsecured loans.
- It can be more difficult to qualify because the eligibility criteria are more strict.
- Your approval may rely on having a good credit score or a high income.
Key Differences Between Secured and Unsecured Business Loans
To summarize the points discussed above, here are some key differences between secured and unsecured business loans:
Secured loans require borrowers to pledge personal or business properties to secure a loan, while unsecured loans don’t.
Secured loans tend to have lower interest rates and longer repayment terms compared to unsecured loans.
Secured loans have higher maximum loan amounts. In comparison, lenders tend to offer lower loan amounts for unsecured loans.
Secured loans can be easier to qualify for business owners with less than favorable financial situations. In contrast, lenders may have stricter credit score requirements for unsecured loans.
Getting approved for secured loans takes more time and effort, while getting funding from unsecured loans is typically a quick and easy process.
How to Decide Between a Secured or Unsecured Business Loan
When it comes to choosing between a secured or unsecured loan, there’s no right or wrong answer. The best loan option depends on your business needs and how well you match the requirements laid out by lenders.
Below are a few criteria you can use to consider whether you should take out a secured or unsecured loan:
What Loan Terms You’re OK With
To see if one financing option is better for your company than the other, run the numbers. First off, know how much you need to borrow and how much your business can afford to pay back. Then research lenders and get information on available loan amounts, interest rates, and repayment terms for both secured and unsecured loans.
The Amount of Collateral You Can Offer
Another thing to consider is how well you match the eligibility requirements. If you have assets to put up as collateral, and you’re willing to do so, a secured loan might be right for you. You can take advantage of lower interest rates and longer repayment terms. Putting up collateral also helps you get approved for a loan if you have a less-than-stellar credit history.
If you’re a new business or startup and don’t have assets to pledge as security, but you have a strong personal credit score and cash flow, an unsecured loan might be the best option for you.
How Quickly You Need the Loan
When deciding between secured loans and unsecured loans, you might also want to consider how fast you need the loan. Secured loans take longer to finalize because lenders might need to appraise the asset you want to put up as collateral. In addition, you’ll need to prepare and present more documents.
However, if you need the cash immediately to cover working capital, you might opt for a short-term loan. In this case, unsecured loans could be the answer to getting the money in your business bank account quicker.
Clarify Capital Helps You Get the Best Small Business Loan for Your Situation
At Clarify, we understand that having capital is a huge part of running and growing a successful business. That’s why we offer solutions for any business financing needs you have.
Our marketplace consists of more than 75 lenders so that you can get the best rates. Fill out our online application or call us today to discover your funding options.