Getting a business loan can be a great way to help your company scale and grow to the next level. But your choice of financing option can make or break your growth trajectory, so understanding the available alternatives is crucial before you sign on the dotted line.
One simple way of distinguishing between loan products is to confirm whether the lending is secured. It’s common to hear lenders mentioning “security” within their terms and products. But while this is a simple concept, it’s a vital consideration for all forms of business finance.
The main difference between the two is that you must pledge collateral when seeking a secured loan, but not with the unsecured option. The latter is issued based purely on your ability to repay.
So if you default, your lender may sue for the amount. Since they don’t have liens against any asset in your company, they can’t seize or foreclose on any property to recover their money. Lack of collateral attachment means that lenders bear the risk. This makes the unsecured loans generally more expensive and more difficult to get approved for.
Read on to understand the key elements in the two loan products and their respective upsides and downsides to inform your decision when seeking business funding.
What’s A Secured Business Loan?
A secured loan is probably the first thing that comes to your mind when thinking of business loans. The financing option uses one or several assets as collateral. These offer a layer of security against which the provider can retrieve the losses in case you default.
The lender faces a lower risk since you’ll provide security, so the terms for this loan type are usually more favorable to you, the borrower. This may include lower interests, larger loan amounts, and the possibility of more extensive repayment terms.
Pros Of A Secured Loan
- Lower interest rates – Collateral is a requirement for secured loans, so the lender has fewer risks. As a result, they’ll generally charge much lower interest rates. With a great credit history, valuable collateral, and solid income, you’ll have vast options to choose from.
- Larger loans – Lower interest rates also come with larger secured loan amounts. It all narrows down to the diminished risk thanks to collateral.
- Better terms – With a secured loan, expect a longer repayment period. Real estate loans, for instance, will often allow you to repay for more than 30 years, which makes sense because the property value will generally appreciate over time and the lender sees it as a safer loan.
- Opportunity to build credit – When you repay the secured loan full amount on the agreed time, your company’s credit rating will improve. As a result, you’ll enjoy better terms next time you borrow.
Cons of a Secured Loan
- Potential asset loss in the case of default – The most evident downside of secured financing options is the risk of losing your possession. The lender can seize the property once you stop paying, regardless of your ownership duration or initial payments.
- Credit damage in default – Just like any loan, failing to pay on time can lead to defaulting, which can substantially harm your credit rating and future borrowing opportunities.
- Asset limitations – Startups and growing entities without significant assets may find it hard to access secured loans.
Common examples of secured loans include construction loans, mortgages, and auto loans.
What’s An Unsecured Business Loan?
Unsecured loans are debts that aren’t secured by underlying assets. Their approval is based purely on your creditworthiness, but they often come with heavy personal guarantees for anyone owning over 20% of the business. This is critical to note – if you sign a business loan with a personal guarantee as an owner and default, it can result in the loss of your house and more.
These loans are relatively costlier and have shorter repayment terms than their secured equivalents. This is because they lack collateral; hence the lender faces larger risks. As such, the option is ideal for those looking for easy-to-access short-term funding that they can repay within a short duration. Notably, only those who meet the qualification criteria can leverage this option.
If you fail to pay, the lender can pursue legal action, hire a collection agency, or even trade the owing debt to a third party. Those requiring a personal guarantee allow the lender to appropriate your possessions if your company defaults on the loan.
Pros Of An Unsecured Loan
- No collateral requirement – Perhaps the greatest attraction to this product is that you can access the funds without pledging an asset.
- Faster approval – These loans don’t authenticate and evaluate collateral assets, hence saving more time. The loan approval process is generally faster because of this.
- Better credit history – An unsecured loan can substantially build your credit history. Paying the amount on time can earn your company a great credit score.
- LOCs (Lines of credit) – Some of these loans offer flexible borrowing and repayment that lets you borrow any amount you need and repay when you can. Although there can be annual fees for access to the LOC, interest only applies to the borrowed amount, not the full amount of the line.
Cons Of An Unsecured Loan
- Higher interest – From the lender’s perspective, this loan is riskier. As a result, expect higher interest rates.
- Higher expenses over time – Since they have higher interest, borrowing to repay over the long term means you’ll pay more, making it a less affordable option.
- Strict qualifications – Qualifying for an unsecured loan is harder. This is because you don’t have collateral to attach, so you must prepare for stricter lending criteria.
Common examples of unsecured loans include business cash advances, lines of credit and more.
Always review all your options and carefully review any agreements when borrowing money for your business – it’s important to have an experienced business law attorney on your side to protect your rights and help your business scale effectively.
If you’re looking at options to take your business to the next level, the team at Wilson Ratledge is here and ready to help. Fill out our contact form or call us at 919-787-7711 to schedule a consultation today.