In the finance world, there are two ways to lend money: secured vs unsecured business loans. This is also referred to as collateralized vs uncollateralized funding.
Secured vs unsecured business loans simplified: If a loan is secured or collateralized, it means you are staking assets on the money you borrowed. If it is unsecured or uncollateralized and you default, the lender cannot automatically take your assets.
Let’s dive in deeper to get a better understanding of what a secured vs unsecured business loan means for your company.
Secured Business Loans
A secured loan uses a piece of collateral, or an asset, to lessen the risk a lender takes when they give a borrower money. If the borrower defaults on their loan, the lender can seize the borrower’s assets to recoup their costs.
What is an asset? An asset is property with value owned by a person or company. Cash can be an asset, but not all assets are cash. A secured business loan could use real estate, vehicles, equipment or cash assets as collateral. Lenders prefer cash assets like marketable securities because they are extremely liquid, meaning they can easily be converted into cash to recoup the lender’s costs rather than having to sell the borrower’s building or equipment.
A car loan and mortgage are the most common types of secured loan, but if your business has poor credit or requires a large amount of money, the loan might be secured as well.
Unsecured Business Loans
An unsecured loan is not protected by any collateral, the lender relies on creditworthiness. If you default on the business loan, the lender can’t automatically take your assets.
Examples of unsecured loans are credit cards, student loans, and personal loans. The alternative funding industry also uses unsecured business funding and does not require any collateral.
Why A Secured vs Unsecured Business Loan?
Why would anyone want to choose a secured loan over an unsecured business loan? For one, it might not be an option if they need a bad credit business loan. It also might be helpful in lowering interest rates, as collateral decreases the risk taken by the lender. Lower interest rates save more money in the long term, just be sure to make your payments on time. Additionally, a secured loan can enable the borrower to get approved for a larger loan amount if they need it.
Secure business loans do come at a risk, as you could lose your vehicle, building, equipment or other cash assets, but that doesn’t mean unsecured loans are risk free. Not paying unsecured business loan payments can still rack up debt and lenders can still go after assets, it would just take a longer legal process.
Some business owners find themselves in a tough spot because they don’t qualify for an unsecured loan, but they don’t have enough assets to get approved for a secured loan. This often happens to minority business owners for reasons explained in this article.
How To Decide Between A Secured vs Unsecured Business Loan
There are many factors to consider when deciding whether a secured vs unsecured business loan is right for your business. It can be simplified into the 5 C’s of obtaining credit:
1. Credit– Do you have a good credit score and if not how can it be better? How is your credit report?
2. Collateral– Do you have any assets to put up? Would you for lower rates and higher amounts?
3. Conditions in the market– Is the market lending with favorable terms? Would waiting for interest rates to drop save you more money down the road? Other economic factors like tariffs or new laws passed?
4. Character– If you have a criminal record of issues with the law, drugs, outstanding liens, etc. you may have problems getting approved as a trustworthy borrower.
5. Capacity– Does your business have the cash flow to pay back more than it borrowed now and forecasted in the future? How much can you realistically take on without being overleveraged?
Forecasting The Future
Deciding between a secured vs unsecured business loan can be tough, but the bottom line is: always make your minimum payments and you won’t have a problem. If you do this, putting up collateral on a secured loan won’t be an issue, but it’s good to acknowledge the future is unpredictable.