Small businesses often must make use of capital-raising tools in order to grow. Expansion opportunities are both expensive and irregular, requiring a keen eye and the right method of finance to achieve. However, small business loans as a term refer to a big tent indeed, categorising many different loans. As such, settling on the best loan for your situation can be difficult.
While there are plenty of small business loans for you to choose from, they can be separated into one of two categories – secured and unsecured loans. Some small business loan lenders will solely provide one or the other, which can help you narrow down your options. In this article, we will discuss secured and unsecured business loans, the implications of taking either, and whether you should consider doing so. Let’s get started.
What are secured and unsecured loans?
Secured and unsecured finance acts as another two categories for loans, both for small businesses and otherwise. Both categories have their pros and cons, and can be quite risky if taken without due care. As such, it’s essential to know both types well before deciding.
Secured loans
Secured loans refer to types of loans that require some form of collateral in order to obtain them. Most physical assets are eligible for use as collateral, though lenders typically have a preference for assets similar to the target of the loan. For example, if you intend to purchase a house, you will be expected to provide property of equivalent value when taking out a secured loan.
As physical assets are of critical importance for secured loans, other factors are not as emphasised. Credit score, while important, is not nearly as vital as it is in other kinds of loan, and neither is business history or other such factors. This makes secured loans quite useful for businesses and individuals that cannot obtain a loan through other means.
Although this emphasis on assets greatly improves the accessibility of secured loans, it does come at the cost of increased risk. If you cannot repay your loan, whatever the reason, your lender is entitled to seize your collateral assets and sell them to recover their capital. As such, this makes secured loans risky for those with rocky finances.
Also Read: Is a Secured Loan a Good Choice With Bad Credit?
Unsecured loans
Unsecured loans are essentially the opposite of secured loans. Unlike secured loans, they do not require any form of physical collateral, with the risk to lenders being mitigated by personal guarantees and higher interest rates. This means that your personal finances will be under much more scrutiny than with secured loans. If you default on an unsecured loan, this personal guarantee will transfer liability from your business to your personal finances. This means that unsecured loans carry less risk than secured loans, but are not entirely risk-free.
As physical assets are not a part of unsecured loans, your application will require information about your credit score, financial history, and proof of stable income. This is to ensure applicants can make repayments, filtering out those with unstable finances. Additionally, unsecured loans will carry much higher interest rates, making such loans more expensive overall. Both factors make unsecured loans less accessible than secured loans, and are likely not an option for those with rocky finances.
Secured business loans vs. unsecured business loans
Small business loans fall into one of the two aforementioned categories, working just as you’d expect, depending on their category. This means that if your small business loan is either secured or unsecured, you should have a clear idea of how it will function. As such, the question becomes which loan you should take.
Key differences between secured and unsecured small business loans
As secured and unsecured loans work quite differently, small business loans can have very different qualities and appropriate uses depending on their category. Secured loans, for example, are much better suited to raising large amounts of capital for use over a long period of time. It is typically a practice reserved for expensive purchases, such as property, land, or large-scale equipment purchases. Although secured loans most often have a longer repayment term, their relatively low interest rates make this term fairly inexpensive. This comes at the cost of increased risk, as borrowers must secure the loan against assets that can be seized in the event they default.
On the other hand, unsecured loans tend to be used for a much smaller-sized loan over a shorter space of time. Naturally, this speed means higher interest rates for unsecured loans, which can make them a more expensive option than secured loans in many cases. That said, you have some peace of mind that your assets won’t be seized, as unsecured loans will not require you to use assets as collateral. This makes unsecured loans ideal for businesses in a stable financial position, but can be difficult or even impossible for those with a blemished credit history.
Which should you choose?
Unsurprisingly, the answer to this question is highly dependent on your situation. Secured loans specialise in granting large sums of money with relatively favourable loan terms, making them ideal for large expansion projects or acquisitions. They are also quite accessible to businesses without a good credit history, or a credit history at all, as is often the case for small businesses. If these perks sound ideal for your business’s situation, you might want to consider a secured loan.
Alternatively, unsecured loans give businesses a small pool of capital with a short repayment term. Such loans are typically quite expensive, coming with large interest rates that can be a struggle for small businesses to cover. However, unsecured loans can still be preferable despite this, as you don’t risk your business’s assets. If your business has a small project it needs funding, and you don’t want to risk losing assets if you default, then an unsecured loan could be right for you.
Conclusion
All in all, small business loans can be either secured or unsecured, giving you much more flexibility in how you fund your business’s projects. Both types have their pros and cons, so doing your research and considering how each loan works with your situation is crucial to making the best choice. With a bit of effort, and some shopping around, you’re sure to find the right loan for your business.