Unsecured loans vs secured loans and what is a personal guarantee?
Welcome to our new Explainer series, where we’ll be helping you understand common phrases in more detail. We want to help clear up any terms you’re not familiar with, so you can make informed decisions on which loan is right for you.
First up we’re taking a look at personal guarantees and the difference between secured loans and unsecured loans. Looking from a borrower’s point of view, below we outline what the terms mean in general. We’ll then go into more detail on what to expect at Funding Circle.
For the most part, secured and unsecured business loans are very similar (although property loans can differ). You get a lump sum, then pay it back in installments with added interest. The key difference comes if you are unable to pay off the loan:
With a secured loan, you put forward something of value as a ‘security’. This could be property, land, equipment or other assets. If you stop repaying your loan the lender could take this asset and sell it to recover the unpaid amount. The loan is secured against the asset or assets chosen.
With an unsecured loan, you do not put forward any assets as a security. That means you don’t have to give up your property, land, or other assets if you can’t make the repayments. The lender may ask instead for a personal guarantee, or simply trust you are creditworthy enough to repay the loan.
What is a Personal Guarantee?
A personal guarantee is an agreement that the person(s) involved will cover the cost of the loan if the business is unable to repay it. Typically this is the Director(s) of the company. They become the guarantor of the loan, meaning their personal assets could be taken if the business fails or is otherwise unable to repay the loan.
Pros and cons
Unsecured loans are usually quicker to apply for as they require no valuation of assets. They are also a useful option if your business doesn’t have any high value assets that you can use as a security.
However, sometimes unsecured loans can have a higher interest rate as the lender is taking a greater risk. Being creditworthy enough to qualify can also be very difficult. Providing a personal guarantee can counter both these problems.
If, however, you would like to keep your personal finances completely separate, a secured loan may be your preferred option.
How does it work at Funding Circle?
At Funding Circle businesses borrow directly from our range of investors, including people, local councils and institutions. They provide all the capital for our loans, and if the loans they fund are not repaid, they could lose part or all of their investment.
So, to help us give investors greater peace of mind about the money they lend, we ask for a personal guarantee from company shareholders on almost all of our business loans.
Unlike some other lenders, at Funding Circle the interest rate you have to pay on your loan will not be affected whether you choose to get a secured loan or an unsecured loan with a personal guarantee. For business loans our interest rate is determined by your risk band (although again property loans can differ). This is worked out using a number of factors such as your credit history, turnover and company finances.
All decisions regarding risk bands and the type of security required are taken by Funding Circle’s Credit Assessment team.
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