There are two basic types of business loans: secured and unsecured. Many business owners don’t have any collateral to pledge for a secured bank loan, and may have difficulty getting an unsecured loan as well, as the banks they do business with don’t offer unsecured loans. Unfortunately, the phrase unsecured business loan is often used in a misleading fashion. If you get an unsecured loan, you’re almost definitely still on the hook if your business fails. The difference between a secured loan and an unsecured loan, in many cases, is not as clear-cut as it may seem at the outset.
Here’s everything you need to know about secured and unsecured loans.
What is a Secured Loan
If your loan is secured, it means the lender has some sort of specific collateral to seize and, if necessary, resell in the event that you can no longer repay your loan.
Perhaps the most common example of a secured loan is a mortgage. Or, in the case of a business loan, a restaurant owner might put up their kitchen equipment as collateral. As long as you have collateral equal in value to the amount of money you’re attempting to borrow, you can get a lot of money at very good rates. Established businesses that have valuable collateral they can put up are eligible for secured loans, while startups and newer businesses usually are not eligible.
Pros Of Secured Business Loans
Borrowing fees and loan terms are more borrower-friendly compared to those of unsecured loans.
Cons Of Secured Business Loans
You could lose whatever collateral you put down for the loan in the event that you default.
Secured loans are inaccessible to startups and businesses that don’t have any significant assets.
What is an Unsecured Loan
Simply, an unsecured loan is one that isn’t backed by any form of specific collateral, such as a vehicle, piece of heavy equipment, or your accounts receivable. The lender will base their decision to lend you money on your creditworthiness (often determined by your credit score) and/or the strength of your business’s cash flow.
Because it’s much more difficult to reclaim money if you default on the loan, unsecured loans are much riskier than secured loans. And as we all know, the riskier the loan, the more it’s going to cost you. Expect to encounter higher interest rates than you would get on a secured loan. However, there are also unsecured loan options available to newer businesses.
It’s important to realize that while a loan may be “unsecured” because it is not tied to any specific collateral, the loan may still require a personal guarantee. A personal guarantee is an agreement which states that if the business can no longer repay the loan, whoever signed the personal guarantee is, well, personally responsible for repaying the remaining balance. Know that if you’re the owner of a sole proprietorship or general partnership, you are already personally responsible for repaying all business debts. Yet, as long as a loan is not tied to any specific collateral, lenders are still able to advertise it as “unsecured.”
Pros of Unsecured Business Loans
They’re easier to get—you can qualify even if you don’t have any compelling business assets.
You won’t bear any personal responsibility if you default—provided that your business is structured as an LLC and provided that the loan doesn’t require a personal guarantee (though most unsecured loans do, indeed, require a personal guarantee).
Cons of Unsecured Business Loans
May require a personal guarantee, which means you are personally responsible to repay the loan if you default (the same is true if your business is structured as a sole proprietorship or general partnership).
First of all, if you come across a lender that’s advertising “unsecured” loans, be very careful before entering into an agreement with them. Quite frankly, in the context of business loans, the word can be used in a misleading fashion.
You’re going to be hard-pressed to find a lender that will give your business any sort of capital, unless they have some guarantee they’ll get the money back. When searching for a business loan, don’t bother looking for a so-called “unsecured” loan. Instead, look for a loan that is secured in a way that works for you.
If your business can’t get a bank loan because you don’t have collateral, take a look at some of our small business loan reviews.