When you need funding for your small business and you look up loans, certain terms and conditions might worry you. Namely, the prospect of collateral – assets a lender can seize if you default on your loan – can be concerning. That said, not all small business loans require collateral. To decide whether the types of loans best for you require collateral, you should ask: Is a small business loan secured or unsecured?
Is a small business loan secured or unsecured?
A small business loan can be either secured or unsecured, but not both. Many of the loan options that small businesses funding experts most highly recommend are secured. Other funding routes for which a greater number of small business owners might qualify are often unsecured. The differences between these two types of loans – and what lenders often do to account for these differences – can explain why.
What is a secured small business loan?
Secured business loans are any type of funding you must back with collateral. That collateral could be property, equipment, or virtually any other asset. The total value of all items you put up as collateral must be equal to at least the loan amount.
Securing loans allows lenders to offer lower interest rates. That’s because secured loans give lenders something to recoup and sell if you can’t repay your loan. As such, lenders don’t have to earn as much interest on these loans.
What is an unsecured small business loan?
Unsecured loans are any type of money you borrow without putting up collateral. Qualification for unsecured loans is typically based on your creditworthiness. These loans also leave lenders unprotected if you default. That’s why lenders often charge higher interest rates on them: They’re riskier for lenders, and collecting more interest helps to offset that risk.
Given the high risk that lenders face with unsecured loans, new businesses rarely qualify for them. Loan amounts are often low too, hovering around $50,000 at most.
Are your assets safe with unsecured small business loans?
Notably, some unsecured small business loans can still put your assets in peril. These loans require you to sign one of two clauses that give lenders recourse if you default on your loan. Below are explanations of those two causes.
- Blanket lien. If you must sign a blanket lien to obtain an unsecured loan, you might wind up in a worse place than if you’d declared collateral. That’s because a blanket lien gives a lender the right to seize any of your business assets if you default on the loan. All your property, equipment, inventory, and accounts receivable could be on the line. Collateral, on the other hand, permits lenders to seize solely a handful of items.
- Personal guarantee. A personal guarantee is basically a blanket lien for your personal assets. When you sign a personal guarantee, you give the lender the right to seize your personal property, bank account, and more. Notably, since this provision concerns your personal, not business, assets, the liability protections of corporations and limited liability companies (LLCs) don’t apply.
Pros and cons of a secured business loan
A secured business loan can seem intimidating since you risk ownership of certain assets when you take out such loans. But there are plenty of reasons these loans are common. In fact, minus the potential for asset forfeiture, these loans are often the better choice. Below are some pros and cons to consider.
Pros of a secured business loan
- Lower interest rates and longer repayment terms. Small business owners looking for smaller monthly payments and low rates should turn to secured loans. In fact, if you compare several secured loans, you’ll probably notice consistently low interest rates and long repayment periods. That’s how you wind up with small monthly payments for which you can easily budget.
- Larger loan amounts. Since secured business loans are less risky for lenders, you can typically find them in larger amounts. In fact, for large purchases such as commercial real estate, secured business loans might be your only option.
- Clearly defined collateral. The business liens and personal guarantees that sometimes accompany unsecured loans aren’t part of secured loans. Instead, only the items that you list as collateral in your loan agreement are open to seizure. Sure, the prospect of losing those items can be worrisome, but at least you know you’ll lose only them.
Cons of a secured business loan
- Collateral. Even if your loan agreement clearly defines your collateral, it would obviously be better if you could obtain funding without risking asset forfeiture. That’s not quite possible with a secure business loan despite its many advantages.
- Potentially longer loan application process. Most of the best small business loans are secured. Most of the best small business loans are also known for their lengthy, tedious applications. Applying for unsecured loans such as business lines of credit is typically a faster, easier process.
Pros and cons of an unsecured business loan
If the notion of putting up collateral scares you, then you might be considering an unsecured business loan. For certain small business owners, these loans can be the right choice, though avoiding collateral might not be worth these loans’ drawbacks. Below are some considerations know.
Pros of an unsecured business loan
- No collateral. The obvious benefit of going the unsecured route is that you don’t need to put up collateral. In theory, this stipulation keeps your assets safe from seizure. In reality, some unsecured loans include other terms that could endanger some assets.
- Easier qualification. In some cases, unsecured business loans are easier to qualify for and obtain than secured loans. For example, most credit cards – which are revolving loans – are unsecured.
Cons of an unsecured business loan
- Potential for blanket liens and personal guarantees. Some unsecured loans require you to sign blanket liens or personal guarantees. These clauses respectively give the lender the right to seize any of your business assets or personal assets. Since you haven’t declared specific items as collateral, these loans are technically unsecured. However, they’re just as risky as – if not riskier than – secured loans.
- Higher interest rates. The higher risk that lacking collateral poses for lenders means they’ll likely charge you more interest. You might thus pay more on top of your loan amount to avoid putting up collateral. And if you’re confident you’ll never default or otherwise need to forfeit your assets, that extra expense is probably unnecessary.
- Smaller loan amounts. The high lender risk of unsecured loans typically makes their amounts smaller. After all, the less money lenders can put into their highest-risk loans, the better. If you need large amounts of funding, unsecured loans probably won’t get you there.
Should you get a secured or unsecured small business loan?
Although your choice between secured and unsecured loans depends on several factors, a few stand out as the most important. For starters, there’s the question of liability. Secured loans put certain assets of yours up for potential seizure if you default, whereas truly unsecured loans protect your assets. Of course, if your unsecured loan requires a blanket lien or personal statement, it’s riskier than a secured loan.
Either way, secured loans typically give you access to larger amounts of money, at lower interest rates, with lower monthly payments. That said, the application process for the best secured loans, such as SBA 7(a) loans, can be lengthy and tedious. But the borrower-friendly terms are often worth that burden and the potential prospect of asset seizure. Plus, if you’re confident you won’t default, collateral is more of a formality than a threat.
- Secured loans typically have better rates, terms, and monthly payments.
- Unsecured loans avoid the burden of collateral, but only if they don’t require blanket liens or personal statements.
How to more quickly apply for secured loans
Often, the process of applying for a secured loan can be time-consuming. Certain online lenders have stepped in to create a paperless application – minus any documents you need to scan – that expedites the whole process. SmartBiz®, for example, offers an entirely online application for secured SBA 7(a) and bank term loans. Just create a SmartBiz account to start the process.
WHAT YOU NEED TO KNOW: The SmartBiz® Small Business Blog and other related communications from SmartBiz Loans® are intended to provide general information on relevant topics for managing small businesses. Be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed. Please consult legal and financial processionals for further information.