Unsecured Business Loans Vs. Secured Business Loans

1. What is a Secured Business Loan?
2. What is an Unsecured Business Loan?
3. Unsecured Vs. Secured Loan: A Comparative Analysis
4. Choosing the Right Type of Loan for Your Business
5. Impact of Credit Scores on Loan Choices
6. Future Trends in Business Lending

Business loans are an invaluable tool for any small or midsize operation finding its feet. The extra injection of capital offers more flexibility, allows for strategic investments, and can help finance revenue-generating equipment and inventory. However, the type of collateral a business can offer up as security for the loan plays a critical role in determining the loan’s terms — and the type of loans available to them.

Entrepreneurs looking to access capital often must choose between two types of small business loans — secured and unsecured. Secured loans, backed by physical assets such as real estate, usually offer better terms because they rely on tangible, guaranteed collateral.

Now, most small businesses don’t own physical collateral like real estate, necessitating the need to put up other forms of collateral — for example, unpaid invoices. This is referred to as receivables-based financing, and its collateral is often considered weaker from the point of view of the lender. This is because, unlike tangible real estate or equipment, receivables are future-based, intangible, and not guaranteed.

So, in which circumstances is a small business loan secured or unsecured? What are the major differences between the two? And, which factors should a business consider when making the choice?

If you’re looking for answers, consider this in-depth guide.

What is a Secured Business Loan?

How does a secured loan work?

Essentially, a loan is considered secured when a business puts up a specific piece of collateral that can be claimed by the lender in case they default on payments. The collateral pledged could be inventory, machinery, or commercial real estate.

There are several benefits of collateral business loans. Some prominent ones include:

• They usually have more favorable interest rates and terms
• Lenders could potentially offer higher lines of credit
• They are easy to qualify for — as lenders prioritize the value of collateral over other factors like credit scores.

At the same time, there are drawbacks. The most obvious is that the lender is legally allowed to seize your prized asset in case you fail to repay.

Beyond that, to even secure such a loan, businesses must have assets valuable enough to back a large percentage of the loan amount. This collateral will also need to be appraised, which can potentially be a time-consuming process.

Lenders may offer other types of secured loans that are considered riskier— such as a business line of credit and merchant cash advance.

What is an Unsecured Business Loan?

Unsecured loans are also known as no collateral loans, because they don’t require borrowers to pledge assets to access working capital. Instead, their terms depend on factors like business credit scores and relationships with the lender.

Such loans help businesses grow during their early stages when they don’t have assets valuable enough to offer up as collateral. Consider two of its most prominent benefits:

• These loans don’t require any collateral, meaning less risk to the borrower
• They are usually approved and processed very fast, often within 24-48 hours.

At the same time, unsecured loans have their share of drawbacks. Without the assurance of collateral, lenders may charge higher interest rates.

These loans also have strict eligibility criteria — as they are contingent on a business’s credit history and reputation rather than the value of an asset. Furthermore, while businesses don’t risk losing an asset when they fail to repay, they risk tanking their credit scores and making it harder to secure capital in the future.

Lenders may offer several types of unsecured loans, including equipment loans, unsecured lines of credit, and more.

Unsecured Vs. Secured Loan: A Comparative Analysis

Here is a comprehensive overview of the difference between secured loans and unsecured loans based on crucial factors.

Choosing the Right Type of Loan for Your Business

How can understanding secured loan terms or an unsecured loan’s definition actually help when applying for a small business loan? Here are some factors to consider.

• Availability of Collateral: Without physical collateral, you may see more benefits in opting for receivable-based financing.
• Creditworthiness: If you have a poor credit history or not enough experience building up a good credit score, you may have no choice but to opt for unsecured financing or receivable-based options.
• Cash Flow Considerations: Assess your budget carefully to determine whether you’re capable of paying higher interest rates over time or if it makes more sense to risk putting up collateral in favor of a better cash flow
• Intended Use of Funds: A secured loan is generally more favored for long-term investments and expansion plans, while an unsecured loan is generally considered better for quick access to working capital.
• Risk Appetite: If you’re confident in your ability to repay, offering collateral can provide an added layer of security and potentially lower your interest rate.

Consider these examples: A relatively new IT startup that is looking for funds to scale operations and has a promising revenue outlook is more likely to opt for a loan without collateral — as it can’t afford to put up significant assets as a safety net.

On the other hand, a welding company looking to finance equipment for its workshop will benefit from pledging the new equipment as security and relying on the increased revenue and favorable terms to pay back a secured loan without defaulting.

Impact of Credit Scores on Loan Choices

While secured loans are contingent on the value of the collateral offered, it is always easier to get a small business loan with a better credit score.

Businesses with bad credit are unlikely to be approved for unsecured loans. But even in the case of secured loans, a better credit history can help you land favorable terms and puts you in a position to negotiate with lenders.

Here are some tips to maintain a good credit score:

• Update all information regularly and accurately with financial bureaus
• Make all vendor and loan payments on time
• Maintain a low credit utilization ratio
• If you can make payments on time, consider opening new lines of credit, as this can bring down the current credit-utilization ratio.

Future Trends in Business Lending

Are small business loans secured or unsecured? Well, in this digital age, the choice is not so clear-cut. The fintech industry’s impact on business financing has been revolutionary — offering small businesses a host of alternative lending options.

Many of these modern loans, including receivable-based financing, combine the best features of both secured and unsecured loans. This modern approach allows businesses with poor credit to access working capital by leveraging unpaid invoices rather than physical assets, reducing the need for collateral.

In the future, disruptive technology can also result in advanced credit assessments.

For example, FinTech firms have already begun implementing AI and big data to determine the creditworthiness of an organization in real-time. This will prove to be a game-changer for small businesses with limited credit history — and blur the lines further between secured and unsecured loans.

Conclusion

There are many factors that go into consideration when considering the right business loans for small businesses. Organizations not only need to decide on the type of loan based on credit scores and cash flows, but they also need to consider the long-term implications of the various options at their disposal.

Because every business’s needs and requirements are so unique, it’s crucial to consult with an expert who understands how business loans are secured when making the choice. A professional can help outline the ins and outs of business loan security, better define borrowing costs, and ensure that you negotiate more favorable terms.

1. Unsecured Loan: What It Is, How It Works And How To Get One
2. What Is a Secured Loan?
3. Is a small business loan secured or unsecured?
4. Is a Small-Business Loan Secured or Unsecured?