Most entrepreneurs must eventually address the question of “which type of financing is best for my small business?” While there are unique advantages to both unsecured vs. secured loans, understanding what unsecured vs. secured loans entail and reviewing the differences prior to actively pursuing financing is an essential first step.
What is an Unsecured Small Business Loan?
An unsecured loan is the most common type of financing for small businesses. When a business (or individual) acquires this type of financing, the lender does not take any ownership of the company’s assets. In other words, you don’t need to provide collateral such as equipment or real estate that the lender can repossess in the case of default on the loan. This also creates the least amount of long-term risk for the business owner, because if the loan is paid back on time the lender has no stakes or interest in the future operations or profits of the business.
What is a Secured Small Business Loan?
A secured business loan is a form of financing in which the lender agrees to secure the repayment of their loan with collateral. The easiest way to think of the way this loan works is that it works just like a consumer car loan or mortgage. If you default on this loan, the lender has the right to take possession of the collateral. Businesses commonly use real estate as collateral because it is one of the most secure assets available, but lenders will also accept mature stocks, bonds, or equipment in many cases. The lender will only provide financing of either an equal or lower amount of collateral.
Key Differences Between Unsecured vs. Secured Loans for Small Businesses
Besides the key factor of borrowing against collateral there are a couple important underlying factors that are important to note when deciphering the difference between the two.
- Interest Rate: Secured loans often include lower interest rates because the bank is protected from losing its money by the collateral
- Loan Limit: Technically an unsecured loan has no upper limit on borrowing. While many lenders will enforce their own upper limit policies, creating a positive borrowing history with a lender will often allow that limit to increase over time. As mentioned above, a secured loan is limited by the value of the collateral provided.
Which type of loan is right for you?
It can be difficult for business owners to choose between an unsecured business loan and a secured business loan. There are several factors you need to think about before deciding on which loan type to pursue:
- Does my business have a strong credit score and history?
- Has my company borrowed from a lender before?
- Can I afford to pay the additional interest on a loan without collateral?
- Do I have assets that I can (and am willing to) provide as collateral?
- Are these assets valuable enough to secure the amount of financing I need?
If you can answer “yes” to questions #1 and/or #2: You are well positioned to receive an unsecured loan given your ability to also answer “yes” to question #3.
If you answered “no” on the first couple questions: You would need to consider questions #4 and #5 carefully before approaching a lender.
Conclusion
Even the most successful startups and small businesses require outside financing eventually to meet the demands of scaling up. Getting approved for either type of loan requires attention to your credit, preparation with financial advisors and stakeholders involved in your business, and an accredited lender like Fundbox. While your credit history will play a significant role in getting approved, going into your preparations with a basic understanding of the key differences between unsecured and secured small business loans is a great starting point.
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