Small business loans come in various forms, providing different options for businesses across industries. Although there are many types, business loans can be categorized as either secured or unsecured loans. One of the main factors that determines whether a loan classifies as secured or unsecured is collateral.
Collateral refers to the assets that are offered to guarantee the loan, such as valuable property owned by the applicant. With the use of collateral, the property can be seized if the borrower is unable to pay the loan. Getting approved for a business loan can essentially put property at risk, so it’s important to understand the differences between secured and unsecured business loans and how they work.
- A secured business loan requires collateral in the form of business or personal assets as a guarantee for the lender.
- An unsecured business loan doesn’t require collateral, although lenders may ask for a personal guarantee instead.
- The main difference between a secured loan and an unsecured loan is the use of collateral, although there are other differences in the requirements, interest rates, and terms.
What’s the Difference Between Secured and Unsecured Business Loans?
The main difference between secured business loans and unsecured business loans is the use of collateral. Secured loans are guaranteed, so lenders are generally more lenient with terms and requirements; unsecured loans have more restrictions because they are not guaranteed with collateral.
|Secured Loans||Unsecured Loans|
|Collateral Requirements||Collateral required||Collateral not required|
|Credit Score||Credit requirements more lenient||Good credit score and history required|
|Interest Rates||Lower interest rates||Higher interest rates|
|Personal Guarantee||Not required due to use of collateral||May be required by some lenders|
A secured loan is named so because it is “secured” with collateral. This means the business must provide property as a guarantee in case the business doesn’t make the payments. An unsecured loan, on the other hand, doesn’t require any collateral. Examples of collateral include assets of the business, such as property, inventory, and equipment.
Generally, lenders will conduct a credit check regardless of their requirements; however, secured loans provide leniency with those requirements. An unsecured loan will have more strict standards since the loan relies more on the information in the credit report to make a decision. This credit check may reference your personal or business credit, and sometimes both.
Secured loans offer lower interest rates because the lender doesn’t consider these loans to be risky. An unsecured loan typically has higher interest rates since the loan is not guaranteed. Secured loans also provide other favorable terms due to the lower risk, such as longer repayment terms and the ability to borrow larger amounts.
A personal guarantee is another way a business loan is approved, and may be required of unsecured loans. It is offered by the individual who is applying for the business loan, and provides a promise that the loan will be repaid using personal assets if needed. This makes the individual personally liable for repaying the loan and puts their personal assets at risk.
Which Is Right for Your Business?
Choosing a loan for your business comes down to the needs of your business and whether you meet the qualifications of the lender. Secured loans can help new businesses that need the funds to cover operational costs.
You should determine whether the expense of added interest and use of collateral is worth borrowing the funds. Secured loans are also a good option for those without established credit due to a higher chance of approval from lenders who know their funds are guaranteed.
An unsecured loan is a good option for those with good credit or who otherwise meet the requirements of the lender. An unsecured business loan may be the best option for business owners with no collateral or those who don’t want to list their property as collateral on a loan. In general, unsecured business loans include more complex terms, stricter requirements, and may require a personal guarantee.
Secured vs. Unsecured Business Loan Example
You may need to consider all options depending on the length of time in which your business has been operating and the amount of revenue your business is bringing in. For example, a new business likely won’t qualify for an unsecured loan since there are generally specified requirements for the amount of time of being in business. This also applies to new businesses that have not met the revenue requirements. As a new business, you may only qualify for a secured loan at first, but as you grow your business, you can work toward applying for an unsecured loan.
Make sure to conduct research when seeking a new loan. Depending on your preferences, you may find favorable terms with different types of loans or with alternative lenders that won’t require being in business for a specified period or having a certain amount of revenue.
Frequently Asked Questions (FAQs)
Are most small business loans secured or unsecured?
Most small business loans are secured in some aspect, whether it’s with collateral or a personal guarantee, as finance lenders aim to minimize risks. Although some banks may offer unsecured options, these are generally harder to qualify for. Therefore, there’s generally more options for secured loans because they are available from both banks and alternative lenders.
How do I get a secured or unsecured business loan?
The process for applying for secured and unsecured business loans is similar. Both generally require an application that requires identification, personal information, contact information, a credit check, and financial statements, business plans, or other documents. The secured loan will require additional information regarding collateral; the unsecured loan may require more financial statements and documents to prove the worth of the business.
Can I get an unsecured loan to open a franchise location?
Many unsecured loans will have stricter requirements for approval, such as revenue and credit score requirements. However, those that have already been in business and are simply expanding may qualify easily. There are also other specified loans for launching businesses, such as real estate financing.
What is the average interest rate for an unsecured business loan?
The interest rate for business loans depends on the financial standing of the business and other factors, such as credit. Some business loans have interest rates as low as 2%, and some alternative lenders may offer loans at 100%. Keep in mind that unsecured loans may be on the higher end because they generally have higher interest rates.
U.S. Small Business Administration. "Unsecured Business Funding for Small Business Owners Explained."
Federal Deposit Insurance Corporation. "Loans."
myFICO. “What’s in My FICO Scores?”
Experian. “What Is a Credit Utilization Rate?”