Understanding the difference between a secured and an unsecured loan is significant while searching for short-term business loans. The loan you choose will decide the interest rate, repayment terms, and any claims a lender has on your assets.
Providing a loan to small businesses is all about risk management. There will be cases of default where the lender will not get his money back. To reduce the risk of loss, loans get approved with collateral security. Sometimes even the unsecured loans are backed up by a caveat or personal guarantee. Every business owner must know the differences between unsecured and secured business loans. So we will be breaking down a few points below.
Secured Business Loans
A secured business loan means borrowing money against collateral owned by you or your company. Collateral can be an asset your business owns, some examples are property, equipment, business bank accounts, inventory, and accounts receivable. A transparent loan agreement will state the type and amount of collateral you use. If you default on your loan and fail to repay it within the terms of the agreement, the lender has the legal right to sell your assets and minimize his loss. The advantages of secured loans are as follows.
- A secured loan will offer a low-interest rate and more favorable terms to your business. It means that you will repay less in comparison to an unsecured mortgage.
- A secured loan can enable you to obtain large amounts for your business depending on available equity
- The loan approval process is easy.
- The loan agreement will mention the assets claimed in case of default. Lending companies have to follow transparency throughout the process.
- The lender has no right to claim the assets not mentioned in the agreement. He can not sell those assets to get his money back.
Disadvantages of secured business loans:
Secured loans have to be backed up by collateral. The problem relies on the fact not every small business owner has assets to put up for getting a loan. The loan amount that gets sanctioned depends on the value of assets you put up. Also, you are at risk of losing the properties if you fail to repay.
Unsecured Business Loans
Many people interpret that unsecured loans are the exact opposite of secured ones. However, this is not always the case. Loans without the backup by any asset offer lower amounts and high-interest rates. To get a completely unsecured loan, a borrower needs an excellent personal credit history and business documents as support.
Lenders are at a greater risk while lending an unsecured business loan. It is because borrowers do not submit any collateral. So in case of default, the lender is at extreme losses. He has nothing to sell off and reclaim his money. Instead of collateral, lenders ask for a personal guarantee or a blanket lien against your unsecured loan.
For an unsecured loan, the borrowers may need to offer a personal guarantee or PPSR charge. Through a PPSR charge, the lender has the right to sell your assets in case of a default.
Although you do not define collateral, property, business equipment, and inventory is at risk if there is any repayment failure. In case of a personal guarantee, the lender has the right to use your bank accounts, finances, property, and other assets for money recovery. Advantages of unsecured loans include:
- No need to provide specific collateral for securing a small loan
- Small business owners who do not qualify for a secured loan may qualify for an unsecured business loan for business growth and expansion.
Disadvantages of unsecured loans are:
- An unsecured loan will mean that your business will have to pay a higher interest rate. Also, the terms of the loan will be less favourable.
- You will not be able to get a large amount.
- These loans require good credit history as well as a business credit history. The documents you need to submit here are also more than a secured loan.
- When you have a PPSR charge, any of your business assets may be at risk in case of default.
- When you give a personal guarantee, the lender can claim any of your assets for his money recovery.
Difference between unsecured and secured business loans in the rate of interest and terms
To manage financial risks, small business lenders charge higher rates. Lending to small businesses is riskier compared to other financing options, so interest rates are higher. Secured loans are backed up by assets and specific collateral. It ensures interest rates and terms to be more favourable for a borrower. Interest rates are higher for unsecured loans, and terms are more challenging because there is a high risk to the lender.
In case of default, the lender can seize your assets to recover their money. But since the borrower does not provide any collateral for an unsecured loan, a higher interest rate compensates for this risk. So you will be repaying more if you take out an unsecured loan.
Summing It Up
Whether you take a secured or an unsecured fast business loan, you need to assess the terms and conditions well. Read your loan agreement well before signing the final documents. Know all the loan terms and understand what you may lose in case of a default. We hope this article will be helpful to all the business owners.