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Updated: March 27th, 2020
If your business is only a few years old or you run an established company, the time will likely come when you need to borrow money. Fortunately for entrepreneurs, getting a secured or unsecured small business loan isn’t as stressful, or difficult, as it once was. Interest rates are expected to remain low for the foreseeable future and the rise of financial technology, or “fintech” has created more competition than ever. And, thanks to tech innovation, lenders have also become more nimble in the way they calculate credit risk.
Whether you’re a startup looking to expand your business or simply need the extra cash to help manage the day-to-day operations of your business, you’re not alone. Even veteran business owners turn to financing to keep the growth going.
More than two-thirds of business owners turned to financing in 2016, according to the latest stats by the National Small Business Association. Research from JPMorgan from that same year reveals that most business owners have a war chest of fewer than 30 days’ worth of expenses should there be any unexpected interruption to cash flow. On the plus side, you’ve got more choices than ever and your options are no longer limited to what banks have to offer.
To help you determine which may be the best source of funding for your business, we’re going to focus specifically on unsecured vs. secured loans. We’ll explore what each is, how they fit in with the greater lending environment today, and how to determine whether an unsecured or secured small business loan is best for your business.
In recent years, the lending market has evolved to favor business owners, meaning that the requirements to securing a loan have become less stringent. Even if there are blemishes on your credit record, that doesn’t disqualify you for a secured or unsecured small business loan. Lenders are using sophisticated algorithms these days to determine creditworthiness that will often go beyond the number. This is especially true for online lenders.
Whether an unsecured or secured small business loan is right for you also comes down to your preferences, such as the amount you’d like to borrow and the type of risk you present as well as can inherit. It’s also important to draw a distinction between unsecured vs. secured loans. It pays to take a deeper look at secured and unsecured small business loans to see which one is the right fit.
With a secured small business loan, the business owner is taking on much of the risk. You must pledge a piece of your own personal collateral – such as real estate, the title to a vehicle, machinery, or equity in the company – to offset the risk of the loan. Getting the loan will be easier because the lender will be more willing to dole out cash if you are willing to do the same. Keep in mind, in the event that you can’t meet the loan requirements, the lender can seize the item, sell it, and use the funds to offset the bad loan.
Think of a secured small business loan like a mortgage or an auto loan, for instance. The lender has the right to repossess the car or foreclose on the house in the event that the worst happens. Also, the amount that you qualify for with a secured small business loan will be directly proportionate to the value of the collateral, so the amount of capital you can access will tend to be lower when compared to an unsecured small business loan.
When you’re comparing unsecured vs. secured loans, the very nature of the latter commands more conditions to be met. For instance, the lender is likely to require that the funds be directed toward a pre-set purpose that’s outlined in the fine print of the loan. While you won’t find much flexibility here, you will find other unique benefits if you dig a little deeper.
Considering that the business owner takes on much of the risk with a secured small business loan, the interest rates are generally lower versus unsecured loans. That’s not the only perk, either. Entrepreneurs can also stretch out the duration of the loan term for a decade or longer. This will free up more cash flow for you to take care of many of the other expenses tied to running a business, whether you’re a startup or a mature business.
Not all business owners have collateral to use to secure a loan or simply don’t want to dip into personal savings or a home mortgage to secure financing. Fortunately, unsecured small business loans are another option, and there are fewer hoops to jump through versus a secured loan. In fact, the process isn’t that much different than filling out an application for a credit card.
Unlike a secured small business loan which can take days, if not weeks, for approval, you could get approved for an unsecured loan in 24 hours or less. It’s a function of the type of lenders that specialize in unsecured small business loans, and that the applications are often online. The terms of the loan are likely to be looser surrounding how you choose to direct the funds, which offers more flexibility.
In comparing unsecured vs. secured loans, you’re not limited to an amount that reflects the value of any asset. So if you are fetching higher amounts, an unsecured small business loan could be for you.
Just be advised, however, that it’s important to read the fine print. Given that the lender is inheriting much of the risk here, a higher interest rate and shorter loan duration are likely to reflect that. This could lead to a cash crunch during those tight times.
Also, the credit standards are higher with an unsecured vs. secured loan. If your business’ books aren’t convincing, the lender might review other types of performance metrics. Keep in mind, if your business becomes insolvent, you’ll likely still be responsible for repaying the lender.
You may find that it’s easier to obtain an unsecured loan with online lenders and fintech companies. Meanwhile, banks may be less willing to take on the risk of an unsecured small business loan. Online lenders are not all cut from the same mold, but many of them have the technological capabilities to deliver fast financing.
You might also consider a secured loan by the Small Business Administration (SBA), but you’ll encounter the similar application and documentation requirements of a bank loan. If you are willing to do the paperwork and don’t mind waiting for the funds to arrive in your account, banks are increasingly looking to recapture some of the business loan market share they lost to online lenders with secured loans. Understanding the pros and cons of unsecured vs. secured loans is a promising first step to getting financing for your growing business.
Chris Capecelatro is Funding Circle's U.S. director of underwriting. Previously, he managed credit risk for a global casualty insurer in addition to working in commercial lending for a local bank.