Every business owner is faced with the need for a small business loan at some point and one of the first decisions you’ll have to make is whether you should get a secured or unsecured loan. When it comes to business financing, secured loans are preferred because of the lower interest rates. However, if you default, the lender can foreclose on your assets. Unsecured loans do not require collateral, but they are much harder to get and cost more than secured loans.
In this blog, we will explain the difference between secured and unsecured loans and help you decide which is best for your business.
Secured vs. Unsecured: What’s the Difference?
The primary difference between the two is that a secured loan requires collateral while an unsecured loan does not. An unsecured loan is offered on the borrower’s ability to repay and if the borrower defaults, the lender can sue but does not have any liens against the property, so they can’t foreclose and seize the property to get their money back.
Since an unsecured loan isn’t attached to collateral, they are riskier for the lender, making them more expensive and harder to get. However, if you do qualify, they are funded quickly.
When most people think of loans, they typically think of secured loans, such as mortgages, HELOCs, vehicle loans, tractor loans, RV loans, equipment loans, etc. A secured loan is a loan that is made against a specific asset and if the borrower defaults, the lender can seize it.
Since a secured loan is attached to an asset, they are less risky for the lender. If you don’t pay, the lender can take the asset and sell it to get their money back. Therefore, secured loans typically have lower rates and longer repayment terms. This is an ideal option if you want long-term financing for an expensive asset that you want to pay for over an extended period of time. Secured loans are typically better if you have bad credit and, in some cases, the only option.
On the other hand, an unsecured loan is a debt that is not secured by an asset, approval is based on the creditworthiness of the borrower. Typically, in the case of business loans, they require a personal guarantee from anyone that owns more than 20% of the business.
Since unsecured loans are riskier for the lender, they are usually more expensive and have shorter repayment terms. Therefore, this is a great option for those who need short-term funding that they can quickly access and pay back within a short time.
However, these are only an option if you qualify. Most of the time, minimum credit scores are 40 to 60 points higher than the minimum for a secured loan. Also, if you have bad credit, most unsecured loans are not an option.
Advantages/Disadvantages of Secured Loans
If you are just starting your business or your credit is not great, a secured loan is a good option and perhaps your only option. Secured loans allow you to lock in lower rates than you would get with unsecured. Finally, if you want longer than 3 to 5 years to pay off the loan, a secured loan is typically the best option.
Underwriting is more complicated because of the collateral
Lender can foreclose if you default
You’ll likely still have to sign a personal guarantee
Advantages/Disadvantages of Unsecured Loans
Typically, an unsecured loan is only an option if your business is well-established and making income consistently. If this is the case and you need quick access to funds, an unsecured loan may be an option- especially if you have the cash flow to pay it back quickly.
Loans can be funded quickly
No worry of the lender foreclosing on your asset
You can be sued if you default
Typically have higher rates and shorter terms
Your decision to get a secured or unsecured loan depends on your needs and what you can qualify for. A secured loan offers lower rates and longer terms and is a great option for those who are building their credit or have lots of outstanding loans. An unsecured loan is ideal for those who need quick funding and have a decent credit score and consistent cash flow. If your business needs funding, contact WCK Financial. We’ll be happy to offer you some guidance.