Explaining Secured and Unsecured Business Loans

An unsecured small business loan is a loan that requires no collateral but rather is based solely upon the creditworthiness of the small business borrower. While an unsecured small [...]

An unsecured small business loan is a loan that requires no collateral but rather is based solely upon the creditworthiness of the small business borrower. Although in the past this type of financing was available to a very creditworthy business borrower, unsecured small business loans may be difficult for many small businesses to obtain.

Banks generally prefer secured—rather than unsecured—business loans. Secured loans are loans that are backed with some sort of collateral like real estate, equipment, or other valuable business assets the bank can seize and sell if the loan is not repaid.

Banks (or other lenders that require collateral) commonly determine what they refer to as the loan-to-value ratio of your collateral based upon the nature of the asset. In other words, your banker may allow you to borrow against 75 percent of the value of appraised real estate or 60 percent to 80 percent of the value of what they call ready-to-go inventory. Because lenders might consider their loan-to-value ratios differently, you’ll need to ask any potential lender how they intend to set that value.

There are other lenders, however, who do not require that your loan be tied to a specific piece or type of collateral and who do not need to value your collateral.  These lenders will typically place a general lien on the assets of the business during the loan term. With this type of secured loan, all of the assets of your business are collateral for this type of business loan.

Why This Type of Secured Loan Could Make Sense for Your Business

Unlike traditional lenders, there are online lenders who might not require the same rigid credit or collateral standards required by the bank. As a result, even if you have less-than-perfect credit or don’t have specific collateral of sufficient collateral value to secure a traditional small business loan, there are loan options available (provided you can demonstrate other healthy business fundamentals). These general-lien loans typically come with a higher interest rate than a loan that collateralizes a specific asset, but do offer some benefits you should consider:

  1. It typically takes less time to apply for this type of business loan: Online lenders have almost become synonymous with quick approval times—even within an hour or less. And, once approved you can have the funds available in your account as quickly as 24 to 48 hours. So if you’re looking for capital to take advantage of a business opportunity that requires you to act fast, it could be a good fit for your business.
  2. This type of loan is not dependent upon the value of the collateral: When applying for a traditional secured loan, the formula for determining the loan amount is commonly calculated based upon a percentage of the specific asset being used as collateral (the loan-to-value ratio described above). In some cases, you may even qualify for more money with a loan that isn’t tied to a specific piece of collateral—because the lender is making loan decisions about your business based upon the health of your business, your cash flow, and your personal and business credit profile.
  3. This type of loan might also help build your credit profile: If your lender reports you payment history to the appropriate business credit bureaus—unlike using your personal credit cards or other financing that doesn’t report to the business credit bureaus—your timely payments will help you build (or strengthen) your business credit profile. Of course this is usually the case with a traditional secured loan too and is important enough that you should ask about it before you sign on the dotted line.

It is important to note that while some lines of credit require collateral, there are also line of credit products available that are completely unsecured (meaning non-collateralized).  These lines of credit, whether secured or unsecured, can be used as needed, repaid, and used again. And, you only pay interest on the amount of credit you use—not any of the available line you don’t use.

Loans backed by specific collateral or backed by general corporate assets aren’t the perfect option for every financing situation, but are tools business owners can use to access capital, provided they are a good fit for the loan purpose and the economics make sense. When looking into any business financing, when talking to a potential lender, make sure you completely understand the terms, the collateral requirements and the costs so you can make an informed decision.