The difference between secured and unsecured business loans can be summed up in a single word: collateral.
Lenders obviously want to be sure to get their money back, so they will try to minimize their risks. For a secured business loan, a borrower pledges a valuable business or personal asset — such as real estate, business equipment, a vehicle, inventory or accounts receivable — as collateral. The collateral lowers the lender’s risk of losing money because it can sell the asset for cash if a borrower defaults on a loan.
With unsecured business loans, on the other hand, the lender doesn’t require any collateral. Instead, the lender relies on creditworthiness for its primary assurance that the borrower will repay the money. Though some traditional lenders offer unsecured business loans, the most common source for this type of funding is an alternative lender. Like secured business funding, unsecured business funding is available as both term loans and business lines of credit.
Unsecured and secured business loans each have certain advantages and disadvantages. Here are some points to consider when deciding if one of them is right for your funding needs.
How Unsecured and Secured Business Loans Compare
Application Approval Process
Though approval of an application for a secured business loan can take several weeks, you can often get an unsecured loan approved in only a few days. Once approved, the money can be deposited into your account in as little as one or two business days.
As stated above, the key difference between a secured and an unsecured business loan is that unsecured financing doesn’t require you to put up collateral. Instead, the lender will consider factors such as your business and personal credit history and your business plan to determine if you are creditworthy.
Some lenders require a personal guarantee from borrowers on unsecured loans. This means that as the owner of the business you sign a document accepting personal responsibility for repaying the debt if your business defaults on the loan. As noted by the U.S. Chamber of Commerce, a personal guarantee gives the lender a legal claim on your personal assets until the loan is repaid.
In some cases, the lender will waive the personal guarantee requirement for businesses that meet certain thresholds for annual revenue and time in operation.
To compensate for the lender’s higher risk of extending a loan with no collateral, lenders typically charge higher interest rates on unsecured business loans than on secured loans.
Higher lender risk also usually translates to lower maximum loan amounts when you’re applying for unsecured funding.
The time you have to repay your unsecured loan will generally be shorter than a repayment term available with a secured loan.
Are Unsecured Business Loans a Good Option?
In the right circumstances, the answer can be yes. An unsecured loan might make sense for your business if:
- You have a good business and personal credit record
- You’re looking to fill a short-term revenue gap to cover an unexpected expense
- You’re financing a piece of equipment with a relatively short lifespan
- You need immediate cash to take advantage of an opportunity to increase your future business earnings
- You’re confident that your cash flow will be sufficient to handle the monthly payments of a short repayment term
Once you’ve weighed the risks and rewards of secured and unsecured business loans, you can decide which small business loan option best fits your current financing needs.