Secured vs Unsecured Debt: Which Loan Type is Right for Your Business?
by Fundid on Dec 1, 2021 10:55:00 AM
A business loan can be either secured or unsecured debt. There are several differences between secured and unsecured loans. Let’s take a closer look at each of these loan types, paying close attention to their advantages and disadvantages to help you choose the best financing option for your business.
What is Secured Debt?
Secured debt, unlike other loan and debt types, requires some form of guarantee. To obtain a secured loan, lenders will make you provide collateral in exchange for the loan. This means that if you fail to repay your loan, the lender is legally allowed to seize the collateral you’ve put up against the loan. Typically, these assets are items of value or pieces of property equal in value to the original loan.
Keep in mind that the type of asset you use to secure your debt can determine the amount you’ll receive. Certain collateral types may be more easily securable than others and will have a higher relative valuation. Commonly used assets include automobiles, real estate, equipment, insurance policies, stock investments, precious metals, and other valuables.
Examples of Collateral to Obtain a Secured Business Loan
There are several different types of collateral options to get a secured loan. Let's take a minute to look more closely at a few of the most common types.
A mortgage is what is used as the collateral when you borrow against a real estate property. If a borrower defaults on their loan, lenders can confiscate the home, building, or property to recover their lost loan amount.
Some loans can be offered using a motorized vehicle to secure the debt. Typically cars, motorcycles, or boats are listed as offered collateral, but other vehicle types may be considered. And as with the mortgages, once the loans are defaulted on, the property–in this case, the vehicle–is seized.
If you are a product-based business some lenders will allow you to use your inventory as collateral to obtain a secured loan. If you default on your loan, lenders can confiscate your inventory. This type of collateral can be harder to use when trying to get a secured loan based on the value of your inventory.
How to Get a Secured Loan and Who Offers It?
Secured loans are offered at most traditional financial institutions like banks and credit unions. Let’s take a look at five key steps you should follow when applying for a secured loan:
- Check your credit score: Before you apply for any credit card, business loan, or other financial venture, you need to check your credit score. It greatly impacts the options that will be available to you, so make sure you take advantage of your bank’s credit checking systems to understand your position.
- Analyze your budget: Next, review your budget to make sure you choose a loan option you can realistically work with. Make sure that you don’t choose financing options that have high monthly payments that you won’t be able to meet. You can help determine your repayment options by checking your business revenue information.
- Assess the value of your proposed collateral: Once you know the loan amount you’re eligible for and have determined the monthly payments you’re comfortable with, take stock of your assets. This step will help you figure out just how high of a loan you can secure.
- Shop for the best loan option: After assessing your credit score and gauging the amount you can borrow, research the available lenders to get the best deal for your business. Don’t just settle for the first option you find–take your time to ensure you’re getting the best deal for your business.
- Submit a formal application: After pre-qualifying with a loan provider, submit a formal application to begin the vetting process.
Interest Rates and Fees Associated with Secured Debt
Secured loans tend to have much better rates than their unsecured alternatives because of the collateral assets.
For example, small businesses with good credit can get rates as low as 3-6%, but keep in mind that qualification considerations may exponentially increase that amount. Additionally, depending on your lender, you may be responsible for covering several other costs including origination fees, application fees, and annual fees.
What Types of Businesses Qualify for Secured Loans?
Secured loans operate on a loan-to-value ratio offered by a lender which may be used to finance a wide variety of small businesses. Most investors use secured loans to finance new business ideas or expand existing businesses.
Women-owned businesses, for example, make up a substantial proportion of small businesses that require financing. Specific industries that benefit from secured financing include professional services, public relations firms, wellness industries, food and beverage, retail, and those businesses operating within the beauty industry.
What is Unsecured Debt?
Unlike secured debt, unsecured loans are a business loan classification that does not require security in the form of collateral assets. Instead, lenders give these loans based solely on the borrower’s creditworthiness and their potential to repay the loan debt. This means that the qualifications for acquiring an unsecured loan are incredibly detailed to allow only the most credible borrowers to take out loans.
Further, when borrowers fail to repay their unsecured loan, the lender will usually send your unpaid loan to a collections agency or take out a lawsuit against the borrower to reclaim the lost money. Defaulting on any loan type will drop your credit score and make it harder for you to obtain future credit.
Examples of Unsecured Business Loans
Let’s take a quick look at two of the most common unsecured business loan types, credit cards, and personal loans.
Credit cards are, perhaps, the most common type of unsecured loan. Typically, these cards come with credit limits tailored to an individual’s personal finances and are repaid monthly.
Business Line of Credit
A business line of credit is a loan type that offers more flexibility than ordinary loans. You will always have access to your approved limit amount as long as you make payments on time. With a traditional business loan, you get a lump sum amount upfront to cover your costs.
How to Get an Unsecured Business Loan
Though banks and credit unions may offer unsecured loans, alternative lenders such as fintech and financial technology firms are more common lenders in this arena. This is because they use automated technology which makes it easier to determine a borrower’s creditworthiness. These lenders set high eligibility requirements that include several different factors including a minimum credit score, the length of time a borrower has been in business, and their annual revenue.
Interest Rates and Fees Associated with an Unsecured Loan
Because unsecured loans have no collateral to insure them, they have much higher interest rates than their secured alternatives.
Usually, unsecured loans have an interest rate between 10.99% to 32%, which is more than triple a secured loan’s minimum interest. As with secured loans, multiple factors can impact the interest rate you receive. These can include your credit profile, income, age, and employment type.
What Types of Businesses Qualify for Unsecured Loans?
Unsecured loans can be a good funding option for small businesses that don’t have collateral or superior credit ratings. And while they may be a comparatively expensive form of acquiring financing, unsecured loans are a fast way of getting business funds. Most small businesses utilize unsecured loans for short-term financial bridging to help them make substantial business steps.
Is an Unsecured Business Loan a Good Idea?
Before you decide whether unsecured loans are the right choice for you, let’s take a closer look at some of their key advantages and disadvantages.
Advantages of Unsecured Loans
- Easy to acquire: Unsecured loans are easier to get than secured loans because they have a faster application and funding processes.
- Fast approval: Most lenders will provide loan approval feedback within 24 hours of an application, whereas secured loan lenders may take a month or longer.
- No collateral required: If you default on your unsecured loan, the lender must obtain a court order to confiscate your business or personal property before taking any action when lenders holding secured loans don’t need to follow as many steps to seize your assets.
- There are chances of a loan being discharged: If you file bankruptcy, the court may consider and discharge the loans, which does not happen in secured loans.
Disadvantages of Unsecured Loans
- Higher interest rates: Due to the risk imposed by unsecured financing to the lender, higher interest rates are placed on unsecured loans.
- Shorter repayment duration: Unsecured financing has a shorter repayment duration, and borrowers may be prompted to make more regular payments than in secured loans.
- Strict qualification parameters: Borrowers with bad credit may find it difficult to obtain unsecured loans.
- Personal guarantees are needed: Most lenders ask for personal guarantees, which prompts the borrower to repay the loan.
Secured vs Unsecured Loan
When you’re determining the loan type that’s right for you, know what you have and what you need. If you have a poor credit score, an unsecured loan might not work for you. But if you don’t have strong assets to use as collateral, a secured loan may not be the right choice. Additionally, consider why you need the loan when choosing one–unsecured loans can be much more flexible and can be used to pay for a wider range of charges while secured loans may not be as flexible.
Choosing the Best Financing Option for Your Business
Once you’ve decided which loan type is best for you, take a moment to consider three key factors that will help you choose the best financier for you:
Every lender will have different qualifications for their borrowers. Make sure you’ve researched your chosen lender well enough to be aware of their specific requirements to save yourself time and potential application fees.
Check various loan providers
Don’t go with the first provider you find–take the time to research several alternatives, paying careful attention to their differing loan limits, interest rates, additional fees, and other factors.
Even if the lender you’ve found sounds absolutely ideal in every other aspect, make sure you carefully check their history and reputation with other businesses. Read reviews–both good and bad–to understand what you’re getting into. Pay attention to elements like their customer service, forgiveness options, and other key factors that will impact your ability to work with them.
Get the Best Business Loans
Business loans can be the make-or-break tool you need to succeed long-term, and finding the right loan provider is an essential step toward that goal. Fundid is re-imagining how businesses get the funding they need to grow to help people just like you. Explore your options.