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Small business loans can be secured or unsecured. Secured loans require collateral to back your loan. Unsecured business loans do not require any collateral. Lenders may offer one or both of these small business loan options, each with advantages and disadvantages.
What is the difference between unsecured and secured business loans?
Most business loan types can be secured or unsecured. Secured loans require the borrower to provide something of value as collateral. This collateral may be business equipment, real estate, vehicles accounts receivable, inventory or another asset. The lender can seize the collateral if the borrower defaults.
Unsecured loans are typically offered to borrowers with higher credit scores. These types of loans do not require collateral because the lender trusts they will repay the loan due to their favorable credit history.
Unsecured business loans often require a personal guarantee, though. The personal guarantee allows the lender to pursue the guarantor’s assets. Typically, lenders require all business owners with a certain percentage stake or higher to provide a personal guarantee.
Examples of secured and unsecured business loans include:
- Term loans
- Business lines of credit
- Invoice factoring
- Merchant cash advances
- Equipment financing
Take a look at the key differences between secured business loans and unsecured business loans:
|Secured business loans||Unsecured business loans|
|Collateral required||No collateral required|
|Lower interest rates||Higher interest rates|
|Typically available to borrowers with minimal credit history or low credit scores||Typically requires a higher credit score|
|Lender can seize collateral if the borrower defaults on the loan||Lawsuit required to initiate collection of defaulted-on loans|
|Borrowing limits are typically higher because there is collateral to back the loan||May have lower borrowing limits because the loan isn’t backed by collateral|
|May require a personal guarantee||Usually requires a personal guarantee|
Secured loan pros and cons
There are pros and cons to getting a secure business loan. Here are some of the benefits and disadvantages of a secure loan.
- Secured loans often come with lower minimum interest rates than unsecured loans.
- Lenders often allow higher borrowing limits.
- It’s easier to qualify for a secured loan.
- The lender can seize the assets you used as collateral if you don’t pay the loan as agreed.
- You must offer acceptable collateral in terms of type and monetary value.
- Your collateral’s value must be appraised, a potentially time-consuming step.
Unsecured loans pros and cons
Unsecured loans have benefits and drawbacks. Here are some to keep in mind when deciding whether an unsecured loan is right for your business.
- The lender must sue you for your assets if you don’t make your loan payments.
- The application process may be simpler because you don’t have to get your collateral’s value appraised.
- If you default, your lender can use legal action to come after your business and personal assets.
- Unsecured loans often have higher interest rates.
- Lenders often require higher minimum credit scores.
Should I get a secured or an unsecured business loan?
Secured and unsecured business loans have advantages and disadvantages, so deciding which is right for you can be hard. Start by seeing if you qualify for each option.
Secured loans may be better if:
- You don’t have a good credit score. If your business is new or you don’t have the credit score needed to qualify for an unsecured business loan, a secured loan can be a good alternative.
- You’re seeking more competitive loan terms. Because secured loans require providing assets as collateral, the interest rate and loan terms are often more favorable. This can include a lower interest rate than an unsecured loan, a longer repayment term or both.
Unsecured loans may be better if:
- You lack assets or don’t want to risk losing your assets. If you don’t have assets you can use as collateral, you need to focus on unsecured loan options. Additionally, if you don’t want to risk losing business assets, an unsecured loan may be the better choice.
- Your cash flow is uncertain. If you are unsure about making timely payments on the loan, the higher cost of an unsecured loan could be worth it.
- You need cash quickly. An unsecured loan can be a good choice if you need cash quickly. Because these loans do not require collateral, you don’t have to wait for asset appraisal for loan approval.
If you can qualify for both types of loans, weigh the advantages and risks of each loan type before determining what is best.
Frequently asked questions about secured and unsecured business loans
There are several types of SBA loans, and the requirements differ among loan types and lending partners. Some lenders may require collateral for a certain loan type, while others do not. For example, lenders are not required to take collateral on 7(a) loans of $25,000 or less. If the loan amount exceeds $350,000, the lender must secure collateral worth up to the loan’s value. Ultimately, you should speak with the lender about the SBA loan type you are considering to learn if they require collateral.
Both secured loans and unsecured loans have benefits. Secured loans are a better option if you have a lower credit score but still want a favorable interest rate. Unsecured loans are a good option if you don’t want to risk your assets and you are willing to take on higher interest rates for the loan. The better option is different for each business.
There are many small business lenders for secured and unsecured business loans, and the application process differs for each lender and loan type. However, some parts of the application process will be similar. You will likely need a business bank account, a business tax ID number, past financial statements for the business and a detailed plan for what you will do with the loan funds. If you are applying for a secured loan, you must also provide collateral and documents proving the collateral belongs to you or your business. Talk to your lender for the specifics of applying for a business loan.