Business Banking

‍Secured vs. unsecured business loans

At some point when a business owner needs more capital they must decide if they want a secured or unsecured business loan. Our article will help you understand which option is right for you.

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Secured vs. Unsecured Business Loans

Although there are many types of small business loans, all of them can be categorized as either secured or unsecured. The difference between these two mostly comes down to collateral requirements.

As a borrower, having to offer up personal or business assets as security for a loan enlarges your overall risk. It also increases the lender’s claim on your assets. At the same time, securing a loan with collateral may guarantee you a lower interest rate and better repayment terms. This may be a worthy consideration, especially if you have bad credit and can’t qualify for unsecured financing.

That is to say, both secured and unsecured loans have their advantages and disadvantages. Ultimately, you may need to weigh up which of these two options makes more sense to your business, and which one you can qualify for.

This article breaks down the differences between secured and unsecured business loans to help you pick the right fit for your business.

Key takeaways

  • A secured business loan is one that is backed by collateral while an unsecured business loan doesn’t have any collateral.
  • Collateral is any business or personal asset that you put up as security for a loan.
  • Types of secured business loans include SBA loans, term loans, equipment financing, invoice financing and business lines of credit.
  • Types of unsecured business loans include business credit cards and merchant cash advances.
  • The main advantage of secured business loans is that you can get a lower interest rate, longer repayment term and larger loan amount.
  • Unsecured loans typically have a shorter application process and a higher chance of discharge.

What is a secured loan?

A secured business loan is any type of business loan that requires some form of collateral or security. These types of loans provide an advantage to lenders by minimizing risk. The upside to borrowers is that the lower risk increases the chances of getting approved by banks, credit unions and even online lenders.

Loan terms, fees and interest rates of secured loans often vary from one lender to another. However, you can generally expect a rate of between 2.54% and 7.02% when borrowing from a bank1. Credit unions typically offer comparable or even lower rates and better terms2 while online and alternative lenders often charge a higher rate. 

 In most cases collateral needed for a secured loan is always in the form of physical assets, property, vehicles and even cash.

Types of secured loans

For small business owners, there are various types of secured loans to choose from. They are often provided by banks, credit unions and online lenders.

SBA loans

While it doesn’t create loans, the U.S. Small Business Administration (SBA) guarantees them, allowing designated lenders to offer low-interest secured loans. You can get business funding of up to $5 million with the SBA 7(a) and SBA 504, and up to $50,000 with the SBA microloan program.

Interest rates start from 5.5% all through 11.25% while repayment terms include 10 years for working capital loans and up to 25 years for real estate loans3. The long maturity period, coupled with fairly low interest rates, makes SBA loans quite affordable. This is why they are so competitive. Lenders typically require a credit score of at least 7204. You’ll also need a 10% down payment and collateral for any amount in excess of $350,000.

Business term loans

With amounts ranging from $5,000 to $600,000, a business term loan may help you acquire equipment, expand your enterprise or cover working capital gaps. The typical interest rate of a business term loan falls anywhere between 2.5% and 71%.

While both banks and alternative lenders provide term loans, it’s generally easier to qualify for an alternative loan than a traditional bank loan. That’s because alternative lenders have less stringent requirements. You can get approved even if your company is a startup with no years in business. Alternative lenders typically don’t consider personal credit scores, which makes their term loans ideal for borrowers with bad credit.

On the other hand, banks and credit unions often require a personal credit score of at least 550, two years in business and a predetermined minimum annual revenue. The maturity period of term loans ranges from three months to 20 years, depending on the loan amount and lender’s terms.

Equipment financing

This type of loan is ideal for buying high-cost equipment and machinery, including vehicles and computer systems. Equipment loans are self-secured. This means that the equipment you purchase serves as collateral for the loan. If you fail to make monthly payments, the lender may seize the equipment.

Equipment loan amounts range from $5,000 to $5 million while interest rates typically fall in the 2% to 20% bracket. Maturity period may be anywhere from one year to 25 years. Although each lender has their own set of requirements, many of them prefer borrowers with a personal credit score of at least 575. You may also have to make a 5% to 20% down payment.

Invoice financing

Invoice financing is yet another self-secured loan. Also known as invoice factoring, it basically involves you selling your unpaid invoices to a third-party (called factoring company) in exchange for a lump sum of cash. You may get up to 90% funding on your unpaid invoices, with the invoices serving as security for the loan.

One advantage of invoice factoring is that lenders don’t typically consider your credit score. This makes it a viable funding option for small business owners with bad credit. However, expect to pay a factor fee of between 1% and 3%.

Another draw to invoice factoring is that it has fast funding. Once approved, you may have the funds in your bank account within one business day. Other loan options take longer. For example, SBA loans typically take between 60 and 90 days for the proceeds to be deposited in your business bank account.

Business line of credit

A business line of credit is a fund that you can draw upon whenever your business needs cash. It works much like a business credit card. However, while a business credit card allows you to make purchases on credit, a business line of credit avails cash that you can spend and pay back at a later date.

Business lines of credit have limits. High-value facilities have limits of up to $10 million. However, the amount that you’ll be approved for will largely depend on your creditworthiness, annual revenue and years in business.

The lender will typically require that you make minimum monthly payments towards your line of credit. This will include all the interest charged on the amount used. While interest rates vary from lender to lender and depending on your credit profile, you can expect a rate of between 0.25% and 35.90%. An annual revenue of $10,000 and personal credit score of 600 are also typical.

Something worth keeping in mind is that not all credit lines are secured. Some lenders offer unsecured business lines of credit.

What is an unsecured loan?

Also known as a signature loan, an unsecured loan is a loan that doesn’t need any type of collateral or security. In other words, lenders do not rely on the borrower's personal or business assets as security. Instead, they approve unsecured loans primarily based on the borrower’s credit worthiness.

As you would expect, unsecured business loans pose a high risk to the lenders. That’s why many of them often require a high credit score before approving these types of loans. In some cases, your lender may only approve you for a loan if you have a cosigner. If you default on the loan, the cosigner will be legally mandated to repay it.

Types of unsecured loans

Many unsecured loans are intended for individuals rather than businesses. These include personal loans, student loans and credit cards. However, some unsecured loans are targeted for small business owners. Examples of these include business credit cards and merchant cash advances. You can apply for them from a range of banks, credit unions, online lenders and other financial institutions.

In a small business context, merchant cash advances and business credit cards offer possibly the best unsecured business loans. They are particularly great if you are unable to access secured loans and at the same time want to avoid taking out a personal loan for business purposes.

Business credit card

A business credit card is ideal for making business purchases and paying bills on credit. You can use the card to purchase inventory, pay utility bills and everything in-between.

Overall, business credit cards work much like personal credit cards. Depending on your company’s creditworthiness, the lender gives you a revolving loan that’s attached to a credit card. You may use the card to make purchases and pay bills on credit. Any amount that you spend attracts an interest, which you have to pay back along with the principal amount spent. Oftentimes you’ll have to make a minimum monthly payment (just as is the case with personal credit cards).

Lenders usually put a limit on business credit cards. This will vary depending on your company’s credit history, annual revenue and years in business. Generally, many credit cards have a spending limit of $50,000, with high-limit cards allowing up to $500,000. Interest rates range from 8% to 24%. However, it’s not uncommon for credit card providers to offer a 0% introductory rate for six to 18 months.

Merchant cash advance

A merchant cash advance (MCA) is an unsecured short-term loan where a financial institution grants your business money in exchange for a portion of your future sales. For example, the lender may give you a working capital loan in exchange for 10% of all the sales that you make via your card terminal. In other words, the lender gets 10% of all the purchases made using debit and credit cards over a predetermined period of time.

Merchant cash advances can be great for many reasons. First, the time to funding is typically short. Once approved, the lender may deposit money in your company’s bank account within one business day. Secondly, you can get anywhere from $5,000 to $200,000, depending on your company’s credit history. For many small business owners, this is more than enough to fill cash flow gaps.

Perhaps the biggest downside to keep in mind is that merchant cash advances usually have short repayment terms. The average maturity period is eight to nine months, but some have shorter terms of three to four months. For this reason, the lender may require that you make daily or weekly payments rather than monthly payments. This can have an undesirable effect on your cash flow.

What is collateral?

Collateral, also known as security, is an asset or an item of value that a lender requires from a borrower before approving a loan request. It acts as a form of guarantee that in case of a default in the loan repayment, the lender can seize the asset and recoup some or all of the amount lent. 

A good example is when you take out a real estate loan, the bank might ask you to provide your home as collateral. In this case if you fail to repay the loan on time, the bank has the right to take ownership of the home and sell it to recover the amount that was lent to you.

Examples of collateral for secured loans

For secured business loans, the lender might require different forms of business and personal assets as a guarantee against your loan. While cash is the most common form of liquid collateral, you may also use tangible assets. These include:

  • Vehicles and automobiles
  • Real estate in the form of homes, land or business property
  • Business inventory
  • Other company assets like equipment and machinery.

If you would rather use cash and cash equivalents, then the lender may ask you to put up your company’s savings account, investment account, treasury bonds, stocks, certificates of deposits and insurance policies.

Keep in mind that in addition to offering up collateral, secured business loans often require you to assign a personal guarantee. Simply put, in case your business fails to make loan payments, the lender could come for your personal assets. Therefore, always check the fine print and disclosures to avoid any surprises.

Pros and cons of secured loans

Secured business loans come with benefits and drawbacks to consider. Perhaps the biggest advantage is that they pose a lower risk to the lender, which may incentivize them to grant lower interest rates and good lending terms. On the other hand, if you fail to make your monthly payments, the lender has the right to seize whatever business or personal assets you listed as collateral.

Here’s a more detailed look at the pros and cons of secured business loans:

Advantages of secured loans

  • Lower interest rates. Since an asset is tied to the loan, the lender may find it agreeable to offer a competitive interest rate. That’s because they may feel confident of getting their money back should you fail to repay the loan.
  • Easier to qualify for. Lenders typically relax their eligibility requirements when you put up collateral. They may consider the asset fronted instead of your credit score or credit history.
  • Higher amounts. By mitigating the lender’s risk with collateral, you may be able to qualify for a larger loan amount.
  • Longer repayment term. While this is not always the case, oftentimes lenders offer longer maturity periods for secured loans. The same can’t be said for unsecured loans like merchant cash advances, which are often due within a few months.

Disadvantages of secured loans

  • Higher risk on borrower’s part. If you fail to repay the loan on time every month, you risk losing the asset you put up as collateral.
  • Not all assets are acceptable. Simply having a personal or business asset is not always enough to qualify for a loan. You need one that the lender can accept. These usually include inventory, real estate, equipment, cash and cash equivalents.

Pros and cons of unsecured loans

The biggest draw to unsecured loans is that they carry minimal risk from the borrower’s perspective. That’s because you’re not required to put up any business or personal assets. On the other hand, the increased risk to the lender usually pushes them to charge a higher interest rate and shorten the maturity period. The argument is that if you can repay the loan faster with higher interest rates, then the chances of you defaulting reduce.

Below are the advantages and disadvantages of unsecured business loans.

Advantages of unsecured loans

  • No collateral needed. As such, borrowers usually have minimal risk of losing personal or business assets. However, if you fail to repay the loan, the lender may report your default to credit agencies, and that will hurt your personal and business credit score.
  • Streamlined loan application process. Unsecured business loans typically have a shorter application process, especially if you’re getting the facility from online lenders like Fundbox. Many of them will let you complete the online application in a few minutes. That’s because there’s no examination and valuation of collateral. Thus the approval process is also swift.
  • Higher possibility of discharge. Since there’s no collateral to repossess, the lender may forgive your loan if you file for bankruptcy.

Disadvantages of unsecured loans

  • Higher interest rates. Unsecured loans pose a high risk to lenders, resulting in higher interest rates. In some extreme cases, the loan agreement may have exceedingly unfavorable terms and conditions.
  • High cost of borrowing. Over a long period of time, unsecured loans cost more to borrowers because of high interest rates. This may affect business cash flow.

Secured vs. unsecured loans: Which should I choose?

When all is said and done, your choice between secured and unsecured business loans comes down to your financing needs and  what you can qualify for. Many unsecured loans require excellent credit, sufficient revenue and at least two years in business. If you meet these requirements, then an unsecured loan may be worth your consideration since the lender won’t ask for any collateral.

However, expect a high annual percentage rate (APR) and short repayment period. The APR is particularly a concern because it can significantly raise the cost of the loan in the long-term. Plus, the lender may charge higher origination fees and lateness penalties to make up for their increased risk. That high cost of borrowing is what can make secured loans more appealing.

Of course, you need to have acceptable collateral to qualify for a secured business loan. Thus, this financing option makes sense if you have cash, cash equivalents and tangible assets that you can use as security. It’s also a more practical option if you want a bigger loan amount. Most unsecured loans have smaller amounts because they are risky credit facilities.

And don’t forget that offering up collateral not only lowers your APR, but it may also relax the lender’s eligibility requirements. Therefore, secured loans make sense when your credit score is on the lower side but you can tradeoff creditworthiness for collateral.

How to qualify for a loan

  1. Create enough time in business to hit the standard two-year mark. However, some lenders like the U.S. Bank require just six months of operation. The same goes for many alternative and online lenders.
  2. Maintain strong business revenue. Most lenders will not only look at your annual revenue, but your debt-to-income ratio as well. Ideally, you want high revenue and few debts. That will convince lenders that you’re able to take on new loans. Revenue requirements vary from lender to lender. For example, Bank of America needs at least $100,000 revenue for unsecured loans and $250,000 for secured options.
  3. Create an existing relationship with a bank through a business checking account. Wells Fargo, for example, requires at least 12 months of banking with them before you can apply for business financing.
  4. Build your personal and business credit. Credit score requirements vary between loan providers. Generally, a personal score in the 700s sends a positive message as far as creditworthiness.

You can boost your personal credit score further by avoiding too much debt, maintaining bank accounts for longer, paying debts on time and avoiding bankruptcies. Your credit score is always checked by the bank for any red flags.

  1. Put up business collateral. While this is not necessary for all types of loans, some lenders may fund larger loan amounts for secured loans. Your loan may also come with a longer repayment term and lower rates, making payments affordable.
  2. Have a business plan. Not every lender will ask for it, but many will. Among other things, a business plan outlines your growth plans, why you need a loan and how you plan to repay it. Ultimately, it makes lenders feel comfortable with giving loans to your business. 

Which bank is the easiest to get a business loan from?

Quite a good number of banks have attractive loan products for small business owners. Below are some banks with fairly easy eligibility criteria and good lending terms.

  1. Bank of America

Bank of America loans are great if you value rewards. With a 25% discount on loan administrative costs, you can save a decent amount on loan fees and charges. Some Bank of America products that are worth a consideration are:

  • Business term loans: typically require an annual revenue of $250,000 for secured loan options while unsecured loans require $100,000. The higher the amount you get, the lower the interest rate. However, you need at least two years in business. Maturity period is up to five years.
  • Business lines of credit: you can choose between secured and unsecured business lines of credit. The latter has a lower limit of $10,000 while a secured line of credit maxes out at $25,000. Whichever option you choose, you are free to use the money as you need.
  • Other business loans: for auto loans, Bank of America offers loan amounts starting at $10,000 while commercial real estate and equipment loans start at $25,000.

  1. JPMorgan Chase

In addition to business checking accounts, JPMorgan Chase offers financing options that business owners can take advantage of. They include:

  • Term loans: you can get fixed- and adjustable-rate loans starting at $5,000 with a repayment period of one to seven years.
  • Business lines of credit: Chase has lines of credit whose limits range from $10,000 to $500,000, with a renewable five-year revolving term. For high-value facilities, commercial lines of credit are available from $500,000 with a one to two-year renewable term.
  • SBA loans: Chase is an SBA preferred lender, which makes the bank great for various SBA loans, including SBA 7 (a) and SBA 504.
  • Other business loans: JPMorgan Chase has commercial real estate loans with fixed or variable rates and loan amounts starting from $50,0000. Terms range between seven and ten years. Equipment loan amounts start at $10,000 with terms of up to seven years. You can also get up to 10% upfront for soft costs like shipping and installation.

  1. Citibank

Citi has many fixed-rate loans, making it a good place to shop if you want the predictability that comes with fixed interest rates. Some available products for entrepreneurs include:

  • Term loans: with fixed interest rates and terms that last up to seven years, Citibank’s loans have amounts from $5,000 to $3 million. But you may need a personal guarantee to secure the loan.
  • Business lines of credit: Citi has two lines of credit to choose from. The first is the Business Credit Account, whose loan amounts range between $10,000 and $250,000. The second is Relationship Ready Credit line, which offers a larger amount of $250,000 to $5 million.
  • Other business loans: you can apply for a commercial real estate loan for amounts ranging between $250,000 and $5 million. Repayment terms include a maturity period of 20 years and amortization of up to 25 years.

  1. Wells Fargo

Wells Fargo is mostly a good option if you already have an account with the bank. They tend to offer friendly terms to current account holders. Some of their business loans include:

  • Business lines of credit: secured and unsecured lines of credit range from $5,000 to $500,000. Rates are extremely friendly, dipping as low as 1% for secured options.
  • SBA loans: Wells Fargo has a strong reputation for granting SBA loans since its part of the SBA Preferred Lender Program. Depending on your creditworthiness, the bank can add to the SBA 504 amount and make it $6.5 million from $5 million.
  • Other business loans: more Wells Fargo financing options include an advancing term loan of up to $500,000 with a five-year term. There’s also equipment financing of up to 100% of the equipment’s cost.

Secured vs. unsecured loan repayment

You’re obliged to repay a small business loan, whether it’s secured or unsecured. Depending on the type of loan, the repayment may be in installments or based on sales. For example, while term loans typically require monthly payments, merchant cash advances are usually repaid with a portion of sales.

In the case of a secured loan, the lender has the legal right to take all the collateral used to recover their money if you default on the loan. If, for example, you put up business premises as collateral, your loan provider can seize and auction the building to recoup their funds.

If the loan is unsecured, the lender can’t possess your asset as a direct consequence of a default. However, they may open a lien and stake a claim to your business or personal assets. These may include real estate property, bank accounts and insurance policies.

Needless to say, both secured and unsecured loans have an impact on your business and personal credit reports. Diligently paying off a loan will improve your credit score. On the other hand, delaying and defaulting on payments will hurt your credit score. Therefore, before taking up any loan, make sure that your business generates enough revenue to meet the associated monthly payments.

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