Secured vs. unsecured startup business loan
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If you’re starting a new business, you’ll need money to pay for everything from equipment and inventory to your employees’ salaries. Startup business loans are one way to get funding for a new company, but choosing between a secured and unsecured loan can be difficult.
Each type has pros and cons that you need to consider.
Secured loans for startups
Secured loans are more likely to be available to new companies than unsecured loans. To get a secured loan, you need to offer collateral. Collateral is something of value that you use to secure the loan and prove your intent to pay back the money you borrow. If you fail to make payment, the lender can seize that collateral.
A well-known example of a secured loan is a mortgage. The home serves as collateral for the loan.
Secured loans are popular for startups because they are much easier to qualify for than unsecured loans. Lenders are often hesitant to lend to new companies with no track record of repaying loans. Collateral reduces their risk, making them more willing to lend.
Secured loan pros
- Easier to qualify for: Secured loans are typically easier to get than unsecured loans. If you can demonstrate basic personal and business financial health, along with showing you have valuable-enough collateral to cover the loan, you’re off to a good start.
- Lower interest rates: Offering collateral reduces lenders’ risk, letting them offer lower rates.
- Some loans let you use the loan to buy the collateral: For example, you can get a loan to buy equipment and use the equipment itself as collateral, which can help you get a loan even if you don’t have assets to start with.
Secured loan cons
- You need collateral: Not every business has assets to use as collateral, so secured loans aren’t an option for everyone. If you have limited assets, that could also impact your borrowing limits.
- Risk: You put your collateral at risk when you get a secured loan.
- Longer approval times: Secured loans are more complex to underwrite, as the lender must verify your collateral’s value. Be ready to face a longer approval and funding timeline, especially if you go for a complicated or government-backed loan like an SBA loan.
Unsecured loans for startups
Unsecured loans are the alternative. Unlike secured loans, you don’t need to offer any collateral to qualify for an unsecured loan. Instead, the lender takes your word that you’ll repay your debts.
Getting an unsecured business loan as a startup is much harder than getting a secured loan. They’re relatively rare until you’ve been running the business for months or years and can show a track record of profitability.
Unsecured loan pros
- No assets needed: Because you don’t have to offer collateral, you can get an unsecured loan even if your company has no assets.
- Less risky: You’re not putting your assets at as much risk with an unsecured loan. However, if you’ve signed a personal guarantee, the lender could pursue your personal assets if you default.
- May be discharged in bankruptcy: It’s typically easier to discharge unsecured loans in bankruptcy than it is to discharge secured loans. With careful debt management and smart business practices, hopefully, this pro will never become relevant to you.
Unsecured loan cons
- Harder to qualify: Lenders may have stricter requirements if you want an unsecured loan. You might have to demonstrate higher revenue or wait until you’ve accumulated six or more months in business.
- Limited borrowing ability: With secured loans, you can borrow large amounts assuming you have sufficient collateral. Unsecured loans typically have lower borrowing limits.
- Higher costs: To compensate for the higher risk, most lenders charge higher fees and rates on unsecured loans.
Which is better for my startup?
In general, most startups will have better luck with secured loans. It can be very difficult to get an unsecured loan as a new company. If you do find a willing lender, you can expect to pay high interest rates.
If your company has sufficient assets to serve as collateral, it’s a good idea to start by looking for secured loans.
If your company has limited assets that won’t serve as effective collateral, you’re left with unsecured loans as an option. To give yourself the best chance of qualifying, you’ll likely need to wait a few months and build a history of profitability to show lenders that you’ll be able to pay back the debt.
Your personal credit is also likely to come into play because the lender will ask for a personal guarantee. Make sure you have good personal credit before applying.
The bottom line
Borrowing money as a startup can be tricky and secured loans are usually your best bet. If you don’t have collateral, you may still be able to find unsecured loans. Regardless of which loan you choose, follow the right steps to apply for a loan and make sure to shop around to get the best deal.