Types of unsecured business loans
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Unsecured business loans help companies borrow money without having to offer valuable assets as collateral. There are many types of unsecured business loans; each works differently and is best for a different situation.
Choosing the right type of loan can help your company get the funds it needs as efficiently as possible. Here’s a look at the most common types of unsecured business loans.
With a term loan, you receive a lump sum of money right away. You then pay the loan off over a series of regular payments, usually monthly. Term loans typically last anywhere from 12 months to five years. The longer the repayment period, the more manageable the monthly payment, but the more you’ll pay in interest.
These loans have the benefit of predictability. If the interest rate is fixed, which is common, you know exactly what you’ll have to pay every month and how long it will take to repay the loan.
The drawback is that they offer less flexibility than other types of loans. If you need funding again, you’ll have to apply for a new loan.
These loans are useful for most businesses but are designed for one-time expenses.
Business lines of credit
A business line of credit gives companies access to a pool of cash they can draw from on an as-needed basis.
The lender will set your credit limit when approved for a line of credit. You can then withdraw money from the line of credit whenever you need extra cash. You can draw funds multiple times so long as you don’t exceed the limit your lender set.
You only have to pay interest on your outstanding balance, but you’re free to pay it down if you want to free up more space in the line of credit.
Lines of credit are highly flexible. You can apply once and get funds multiple times over the life of the line of credit, making them useful for dealing with unpredictable expenses or cash crunches.
The drawback is that lines of credit often have lower borrowing limits than term loans. They also tend to have variable interest rates. That means the cost of borrowing, and your required payments, could rise unexpectedly if rates increase.
Interest rates for lines of credit are also usually higher than term loans. Most businesses can benefit from a line of credit, but they’re best for companies with unpredictable or inconsistent financing needs.
Invoice factoring is a type of financing that relies on the value of your unpaid invoices.
Typically, when you sell a good or service to another business, you’ll send an invoice for the amount you’re owed and a due date for payment. It’s not unusual to wait 30 days, 60 days, or even longer to get paid for the sale.
With invoice factoring, you sell your outstanding invoices to a lender for a percentage of the face value. You get paid immediately, which can help with cash flow problems. Once the client pays the full invoice, the lender releases any remaining funds to you, minus fees.
Lenders are more concerned with the creditworthiness and repayment history of your invoiced clients. So invoice factoring is an accessible form of financing available to startups and business owners with fair or bad credit.
But invoice factoring is only an option for companies that send invoices regularly. You can’t borrow more than you’ve invoiced for, which makes it a poor option for companies looking to borrow a lot of money. It can also be costly since you lose a percentage of your revenues. So factoring might not be a great choice if you’re operating on thin margins.
Merchant cash advances
A merchant cash advance is a type of alternative loan. It offers quick funding, usually for small amounts of money, and is intended for purchasing inventory or paying immediate operating expenses. Typically, you repay these loans through a percentage of your credit and debit card sales.
A benefit of a merchant cash advance is that they are incredibly quick to fund. They also tend to have more flexible requirements for qualifying because repayment happens automatically through your daily sales.
But merchant cash advances can be very expensive. Most use factor rates instead of interest rates to determine the total cost of the loan. Factor rates are fixed costs and typically range from 1.1 to 1.5.
If you borrow $12,000 with a factor rate of 1.5, you’ll owe an additional $6,000, with your total loan cost coming in at $18,000, not counting any additional fees. Using a business loan calculator, you can see that amount is similar to a $12,000 loan with a 41 percent APR and 24-month repayment term or an 80 percent APR with a 12-month repayment term. To find the most affordable loan, convert a loan with a factor rate to one with an interest rate and compare the costs.
|1.5 factor rate||41% APR||80% APR|
|Loan term||12 to 18 months||24 months||12 months|
|Cost of loan||$6,000||$5,777.97||$5,809.16|
|Total loan amount||$18,000||$17,777.97||$17,809.16|
Alternatives to unsecured business loans
Unsecured business loans offer fast approvals and don’t require assets to secure the debt but may have high interest rates and lower loan limits.
If you’re looking for other ways to borrow money for your business, consider these alternatives:
- Secured term loans
- SBA loans
- Secured lines of credit
- Invoice financing
- Business credit cards
- Business grants
- Peer-to-peer (P2P) lending
The best unsecured business loans can come in many forms. Choosing the right one for your situation can help ensure your company gets the funding it needs to keep operating or expanding.
Before you apply for a loan, make sure to take the time to shop around and compare offers from multiple lenders. Look for the loan with the lowest rates and fees and make sure you have a plan to manage your loan properly.
Frequently asked questions
Yes, many banks offer business loans with no collateral. But they may have stricter requirements regarding time in business and revenue. There’s also a good chance they’ll require a personal guarantee.
Yes, some SBA loan programs let you get a loan with no collateral. Usually, you’re limited in the amount you can borrow. For example, lenders are not required to take collateral for SBA 7(a) loans up to $25,000.
Getting an unsecured business loan is typically harder than getting a secured loan, especially if you’re applying for a term loan or line of credit from a bank or credit union. But that doesn’t necessarily mean that it’s difficult. Many lenders target certain loans at newer companies or those with less-than-perfect credit. But if you don’t have strong finances or credit, expect to pay high rates and fees.