What is an unsecured business loan and how does it work?
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If you run a business, there may come a time when you want to borrow money. Whether you’re trying to cover a cash shortfall or invest in growing the company, business loans can be a useful tool.
Many lenders will want you to offer business collateral when you apply, but that isn’t true of all business loans.
What is an unsecured business loan?
An unsecured business loan is a type of business loan that doesn’t require any collateral. Collateral is an item of value that you use to secure a loan. If you fail to make payments, the lender takes possession of the collateral to cover its losses, reducing its risk.
Because unsecured loans have no collateral, the lender takes on more risk when lending money to businesses. That’s why some types of unsecured loans may have strict eligibility requirements.
How unsecured business loans work
Unsecured business loans work very similarly to other types of loans. You submit an application, wait for the lender to decide, and if you’re approved, you get the cash and pay it back over time.
Since there isn’t any collateral involved, lenders are typically more selective about who they offer unsecured term loans to, especially if you want one with low interest rates. They also tend to ask the business owner to provide a personal guarantee. This is a promise to pay the loan back out of personal funds if the company defaults on the loan.
Other types of unsecured business loans have relaxed eligibility requirements and are even available to business owners with bad credit. This includes invoice factoring and merchant cash advances. But these types of loans come with a heavy cost, including high interest rates and fees.
Some lenders will also demand a Uniform Commercial Code (UCC) lien. A UCC lien is a claim against your company’s assets. If your company fails to pay the loan, the lender will come after these assets to recover its losses.
Types of unsecured business loans
There are many different types of business loans, many of which can be unsecured.
With a term loan, you apply for a loan, specifying the amount you’d like to borrow and often specifying the reason for getting the loan. If the lender approves the application, it disburses the funds in a lump sum to your bank account. You then repay the loan in regular installments, typically over three to five years.
These are popular if you want to make a specific purchase and pay for it over the long term.
Business lines of credit
A business line of credit allows your company to borrow money when you need extra cash. You only pay interest on the outstanding balance and can draw funds from the line of credit multiple times.
These are popular for businesses that want to have the flexibility to cover unexpected expenses, though the cost of a line of credit can be higher than term loans.
Invoice factoring involves selling unpaid invoices to a lender at a discount. That lets you get paid for your invoices right away rather than waiting for your customers to pay you. For example, if you have an outstanding invoice for $5,000, a factoring company may buy it from you, giving you 85 percent of the amount ($4,250) and releasing the rest, minus fees once the invoice is paid.
Factoring can be expensive, but many factoring companies won’t require a personal guarantee or collateral. That’s because you sell them your invoices and don’t actually borrow money from the lender.
Merchant cash advances
A merchant cash advance involves getting cash upfront based on your company’s typical sales numbers. You can then use the money to cover unexpected costs or buy inventory.
You repay merchant cash advances automatically through a percentage of your future sales. These can be a good option to help cover seasonal and other short-term cash issues but can get quite expensive and make your cash flow issues even worse, putting you in a cycle of debt.
Where to get an unsecured business loan
There are many places you can look for unsecured business loans, each with pros and cons.
- Online lenders. These companies include fintech lenders like Bluevine. Online lenders tend to have quick applications and funding timelines, making them good for businesses needing quick cash. But they often charge higher rates if your company has less than stellar credit.
- Banks and credit unions. Like Bank of America, these are traditional lenders that you find online and with brick-and-mortar businesses. They usually have slower processes and stricter lending requirements but may have more loan types available. They’re also good for companies that want a more face-to-face experience.
Pros and cons of unsecured business loans
Unsecured business loans have a few benefits, but it’s important to understand their drawbacks before deciding which one is right for you.
- No collateral. The obvious advantage of these loans is that you don’t need any valuable assets that could get seized if you default on the loan.
- Simple applications. These business loans are usually faster because the lender doesn’t have to spend time and effort assessing the value of your collateral.
- Accessible. Some lenders work with bad credit applicants and offer products like lines of credit or merchant cash advances to a broad range of borrowers.
- Smaller amounts. Lenders usually limit the amount of money they’ll lend without collateral, meaning you might not be able to borrow enough for your needs.
- Stricter requirements. You’ll need better credit scores and finances to qualify for the best unsecured loans.
- Higher cost. Unsecured loans are riskier for the lender, so they typically charge higher rates and loan fees than secured loans.
Unsecured business loans can be a great way for companies to borrow money. If your business doesn’t have great finances or has poor credit, a secured loan may be easier to qualify for and more affordable.
Before applying for an unsecured loan, make sure to shop around and compare multiple offers. If you put in the effort, you may find a better loan that will help you save money.
Frequently asked questions
Getting an unsecured business loan can be easy since many lenders offer them. But they may have stricter requirements than loans with collateral and you will likely have to provide a personal guarantee.
To qualify for an unsecured term loan or line of credit, your company will need to have solid revenue and good credit. You may also have to provide a personal guarantee. The eligibility requirements can be far more relaxed for other forms of unsecured business loans, like merchant cash advances or invoice factoring.
Some types of business loans like merchant cash advances and invoice factoring don’t require collateral and are available to business owners with bad credit. Equipment financing is another form of a business loan that doesn’t require collateral since the equipment you purchase acts as collateral. Some online lenders offer equipment financing to borrowers with bad credit.