It takes a lot of money to get a small business up and running. And once your company gets off the ground, you will need cash to meet your growth goals and keep everything running smoothly. These are the times when small business loans come into play. Loans are the most common form of financing for startups and well-established businesses, and there are two different types to choose from: secured and unsecured loans.
Before diving in and applying for a business loan, you should become familiar with both of these options, as each one is unique and has its own advantages and disadvantages. In this Balboa Capital blog article, we compare secured vs. unsecured loans for small businesses. It has all of the information you need to decide which type of loan is right for you.
What is a secured business loan?
This type of loan is backed by collateral that you own, such as a house, automobile, jewelry, stocks, bonds, savings, or business equipment. The lender holds the title or deed until you repay your loan in full. In the event that you stop making your loan payments, the lender can put a lien on your collateral. If you default on your loan and cannot repay it, the lender can legally take hold your collateral and sell it to make up for any losses.
In short, a securitized loan motivates you to make your payments on time so you can avoid having your house, automobile, or other form or valuable collateral taken away. In addition, repaying your loan in a timely manner will prevent you from incurring interest penalties and/or late fees.
How to get a secured business loan.
A secured loan is usually easier to get than an unsecured loan because collateral is required. Banks, credit unions and non-bank lenders are more willing to extend loans that are backed by collateral because they are viewed as less risky. As a result, secured loans typically have lower interest rates than unsecured loans. Of course, interest rates can vary as lenders have their own qualification prerequisites and interest rates. It is also worth noting that secured loans also have higher borrowing limits and longer repayment terms.
In order to get a secured loan for your business, you will need to meet the borrowing requirements of the lender you select. Lenders prefer to extend loans to business owners with good credit scores, strong financials, and who have been in business for at least one year. If you fall short in any of these areas, do not let that deter you. You might still be able to qualify because you are offering collateral.
The application process for a secured loan can be time-consuming because you will need to include financial documents, tax returns and collateral, to name just a few. Review the lender’s application checklist and make sure to include everything that is needed. Before you submit your application, double-check (or even triple-check) the information you provided to pinpoint any errors or missing form fields that need to be addressed. A fully completed application package will help accelerate the review and pre-approval processes.
What is an unsecured business loan?
An unsecured loan is also referred to as a collateral-free loan and, like its secured loan counterpart, is offered by banks, credit unions and non-bank lenders. Research shows that 1 in 4 small business owners applied for unsecured loans last year, and non-bank lenders were the most popular choice for unsecured funding (62%). Many non-bank lenders have made unsecured loans the cornerstone of their business, and this has brought more awareness to this type of funding.
If you cannot qualify for a traditional secured loan, an unsecured loan is a good option. Lenders charge higher interest rates for this type of loan because it is not backed by collateral. In addition, unsecured loans have shorter repayment terms to minimize the lender’s risk.
How to get an unsecured business loan.
As with any type of loan, you will need to show your lender an adequate credit score, a strong financial history, and cash flow projections for a specific time frame. Your lender will also consider how long your company has been operating. Your company’s financial report, particularly its cash flow, will help determine how much you can allocate toward a weekly or monthly loan payment. Most accounting professionals agree that your company’s total income needs to be at least 1.5 times your total expenses, including your loan payment, to keep you from running into cash shortfalls.
The application for an unsecured loan is uncomplicated and straightforward. Most lenders have applications online that you can complete quickly because you will only need to provide basic information about you and your business, along with a few ancillary items such as bank statements. If you end up selecting an online lender, the loan review process can be completed quickly because there is less information for their credit department to review.
Because unsecured loans do not require collateral or high credit scores, they have higher interest rates than secure loans. But if you need cash quickly and have been unsuccessful in getting a traditional secured loan, an unsecured loan might be a great fit. Obtaining a loan, albeit with a higher interest rate than you originally expected, can end up benefitting you down the road. Sure, you will pay a little bit more interest, but you will get the funding you need to keep your business moving in the right direction.
Before you get either a secured or unsecured loan, look at the pros and cons of each. Both types of loans present you with unique benefits, but your decision should ultimately be decided on what is best for your individual situation and budget.