You’ve decided to apply for a business loan. Now, all you have to do is figure out where to get it. If only there weren’t so many options to choose from. It’s safe to say you’d be a lot less overwhelmed if you could narrow down those options. Well, a great way to do this is to decide which type of business loan makes the most sense for your needs: a secured vs. unsecured business loan is a good place to start. Regardless of where you apply, the fundamental differences between secured and unsecured business loans remain the same—do you have collateral? This decision will likely point you in the direction of a traditional financial institution or an online business lender.
But before we get into the pros and cons of each type, let’s clear the air on what makes a loan “secured” or “unsecured” in the first place.
Secured vs. Unsecured Business Loans: Collateral is the Main Difference
The most important difference between secured vs. unsecured business loans is that secured loans require collateral. Collateral is a personal or business asset that the financial institution can sell in the event of a default. Popular examples of collateral include real estate, cars, equipment, or inventory. The term “secured” comes from the “security” provided by the specific collateral. There’s much less risk in approving the loan because the institution has a relatively easy way to make back any money that was distributed.
However, certain forms of collateral, like real estate, take more time to convert into cash. For this reason, some institutions require specific collateral that is more valuable than the borrowing amount. These institutions might also undervalue the collateral because they’ll probably have to sell it at a lower price in order to make their money back as quickly as possible. So, if you decide to apply for a secured loan, you should definitely get an accurate estimate for the asset’s value. You’ll have more negotiating power if you come to the institution with a recent estimate.
Pros and Cons of Secured Loans vs. Unsecured Loans
Secured loans put less risk on the institution and more risk on the borrower. If the borrower defaults, the specified asset is lost. This could be downright catastrophic if the default was the result of the business going under. As if losing your business wasn’t crippling enough, you could also lose your house or your car if you default on a secured loan.
The ability to provide collateral, however, could make it much easier to access lower interest rates, convenient terms, and higher borrowing amounts. Financial institutions charge higher interest rates when they have reason to be concerned about being paid back on time. This concern could be triggered by a less than ideal credit score, less time in business, or lower annual revenue. But if you can provide collateral, some institutions might be willing to disregard these shortcomings.
If you intend to borrow a large amount of money (i.e. at least $250,000), you may have a hard time finding an institution that doesn’t require collateral. An institution that offers such borrowing amounts might only approve secured loans in general.
Lastly, it’s worth noting that traditional institutions tend to require more paperwork and longer waiting periods. You might have to wait several months just to learn you’ve been approved, and even longer to receive funding. That’s the price you pay for accessing the most advantageous business loans on the market.
Pros and Cons of Unsecured Loans vs. Secured Loans
Unsecured loans do not require collateral, which puts more risk on the institution. This risk can be offset in a number of ways. The institution will likely charge higher interest rates, assign shorter terms, and require a personal guarantee. Signing a personal guarantee makes you personally responsible for paying back the debt in the event of a default. You wouldn’t lose an asset but you would have to pay back the debt in installments over time.
Since unsecured loans typically involve lower borrowing amounts, the screening process is significantly quicker. Most institutions that offer unsecured loans can approve and distribute funding in under 48 hours. There’s hardly any paperwork, and the requirements for personal credit, time in business, and annual revenue are much looser. If you have no expensive assets that can be used as collateral, it’s probably because you’re a younger, smaller business with little credit history. The lack of collateral also allows you to spend the money on virtually anything you want.
Deal-breakers for Both Options
As you can see, there are quite a few scenarios that can only be solved by secured or unsecured loans. For example, if you need the money right away, an unsecured loan may very well be your only option. On the other hand, it may be difficult to be approved for a high borrowing limit without collateral, especially if your credit score is less than perfect.
Though secured loans are usually cheaper, this does not mean that all unsecured loans carry outrageous interest rates. Thanks to the rise of tech-oriented industries, expensive business assets are becoming less common. Fewer people are buying cars and houses, too. Thus, more and more institutions are realizing that collateral is no longer an accurate way to gauge the stability of a business. If your cash flow and personal credit are in great shape, you could likely access an unsecured loan that is nearly just as advantageous as a secured loan.
Making Your Decision
Here’s the bottom line: Secured loans usually offer larger amounts and lower interest rates, but unsecured loans are dramatically more accessible and take much less time to obtain. Access might answer the secured vs. unsecured business loans question.
Many businesses cannot meet the requirements for secured loans. But if you work with the right financial institution, every unsecured loan you pay off without trouble makes you eligible for larger borrowing amounts and increasingly convenient rates and terms. So, you don’t necessarily need collateral to reap the rewards of secured loans. You just need a solid track record of unsecured loans and the knowledge that real, sustainable business growth is not achieved overnight.
This article was originally written on March 9, 2020 and updated on June 25, 2020.
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