Small Business Loans: Secured or Unsecured?
Small business loans come in two main varieties: secured and unsecured. With secured options, you provide your lender with collateral — assets they can claim if you default on your payments. Unsecured options don’t require any collateral, which may sound like an automatic win.
The choice isn’t quite that simple, though. Before you decide which is best for you, let’s explore the key differences between each option to make it easier to determine which is a better fit for your small business.
What Are Secured Business Loans?
A small business loan backed by collateral is a secured loan. When you pledge specific business assets as collateral, you give the lender the right to claim these assets if you default on repayment.
Forms of collateral small business owners can offer to lenders include:
Commercial or residential real estate
Business or personal checking and savings accounts
Cars, trucks, or other business vehicles
Machinery or tools used in your operations
Investment accounts like bonds and CDs
Inventory and unsold products
Accounts receivables
Most lenders prefer secured loans because your collateral acts as a safety net. If you can’t keep up with repayments, they can take possession of your assets and sell them to cover the outstanding balance. That’s why secured small business loans usually have lower interest rates than unsecured options.
Lenders base the loan amount they’re willing to offer on the asset's loan-to-value ratio — a set percentage of its worth. Depending on the asset, this can range from 50% for inventory up to 95% for residential property. Each lender has different rules surrounding how much they will lend.
Other Types of Secured Business Lending
In addition to traditional secured term loans, you can apply for secured business lines of credit.
A business line of credit works more like a business credit card. Instead of receiving a lump sum upfront and paying interest on the entire amount, you get a credit limit you can spend up to.
Your balance goes up when you buy something with your business line of credit, and it goes down when you make a repayment. Business lines of credit are popular because you only pay interest on the amount you borrow, making them cheaper than traditional loans in many cases.
Equipment financing could be better for buying equipment, machinery, or vehicles. The item you buy acts as collateral, meaning you don’t need to offer up your business or personal assets as security. However, if you can’t repay the loan, the lender can take back the equipment, which could disrupt your business.
Commercial real estate mortgages are another type of financing secured by collateral. Repayment schedules for this type of financing spread the cost over longer periods. Like with a home mortgage, you’ll typically have 20-25 years or more to repay the balance, with the property as collateral. Once you pay off the loan, the property belongs to your business, but you risk repossession if you fall behind on repayments.
Finding a Secured Business Loan: Where to Look and What to Expect
Most business banks, credit unions, and online lenders offer secured commercial loan options for entrepreneurs.
While offering collateral does lower eligibility requirements compared to unsecured loans, lenders will still thoroughly evaluate your business’s financial health before making a decision. The application process and evaluation can be particularly detailed for large loan amounts.
You may need to sign a personal guarantee. If you default on the loan and the sale of your collateral doesn’t fully cover the remaining balance, your lender is entitled to hold you personally responsible for repaying the remaining amount.
Depending on which lender you approach, they may ask you for a business plan to show how you’ll use the money.
When you apply, you might need to provide documents like your personal and company tax returns, bank account statements, and profit and loss statements. This is so they can assess your cash flow, annual revenue, and other key metrics to check that you can afford the repayments. They’ll also check your personal and business credit scores.
If you don’t meet a lender’s requirements, you can apply for finance through the SBA loan program. Many SBA loans, like the SBA 7(a) and SBA 504, are also secured. Since the Small Business Administration guarantees part of the loan, lenders may view your application more favorably, giving you a better chance of approval.
Use Cases for Secured Loans
Secured funding might be a good fit in these situations:
Expanding your manufacturing facility: You can offer your real estate or business equipment as collateral to borrow larger sums of money at lower interest rates.
Buying expensive equipment: If you need costly machinery to expand capacity, you could access higher borrowing limits and longer repayment terms with a secured loan.
Managing seasonal revenue fluctuations: Getting your business through low sales periods can be easier when you access low-cost funding with predictable monthly payments.
Renovating your business property: If you want to improve your current space, a secured loan for your property may be less expensive than an unsecured funding option.
Pros and Cons of Secured Business Loans
Secured business financing comes with the following advantages and disadvantages.
The pros of secured business loans are:
Cheaper credit: Collateral makes the loan less risky for the lender, so you’ll usually benefit from lower interest rates.
Higher borrowing limits: A secured loan allows you to borrow more, which is great if you’re planning a large project or need access to a lot of capital.
Longer repayment periods: Repay your loan over a longer period to keep monthly payments manageable and ease cash flow pressures.
Easier approval: You have a better chance of getting approved by offering valuable assets as collateral, even if your credit score isn’t perfect.
Builds your business credit: Making payments on time boosts your business credit, making future borrowing easier and cheaper.
The cons of secured business loans are:
Risk of losing your assets: If you can’t make your payments, the lender can take and sell the collateral you’ve pledged, whether it’s equipment, vehicles, or real estate.
More paperwork: Secured loans take longer to process as the collateral you’re offering may need to be professionally valued, which you may have to pay for.
Slower approval: Lenders need time to check and verify your assets, business plan, and documentation, which isn’t ideal if you need funds quickly.
Limits on what you can do: Your lender may claim future rights to your collateral, so you can’t sell it until you pay off the loan.
Bad if you default: If a lender repossesses an important business asset, keeping your business running and meeting customer demands may be very difficult.
What Are Unsecured Business Loans?
Unsecured business loans are financing options that don’t require collateral. However, some lenders may still ask you for a personal guarantee or a blanket lien.
Blanket liens allow lenders to claim your business assets if you can’t meet your loan agreement terms. This does not normally include personal assets — just company property or equipment.
You can often get funding through unsecured business loans faster since there’s no need to provide collateral. But even with an excellent credit rating, these types of loans can be harder to qualify for, and you’ll pay higher interest rates.
Other Types of Unsecured Business Lending
Other unsecured financing options for small businesses include unsecured business lines of credit and business credit cards.
Short-term working capital advances give you quick access to funds for immediate expenses like payroll, inventory, or other unexpected costs. Approval usually depends on your business’s cash flow and financial health, making these advances a flexible way to manage short-term needs without the hassle of traditional loans.
You can also borrow against future credit and debit card sales with a merchant cash advance. Invoice factoring lets you sell your unpaid invoices to a lender, who pays you up to 90% of the invoice value within 24 hours and the remainder, minus their fee, once your customer pays.
Where You Can Get Unsecured Loans From
Like secured funding, you can apply for unsecured finance from banks and credit unions.
Online and alternative lenders often specialize in providing unsecured financing, offering borrowers faster approval times and more flexible criteria than traditional banks. They’re also a good option if you don’t meet the often strict requirements of banks, and they can provide quick access to funds even if you have a limited credit history.
Use Cases for Unsecured Loans
Here are some practical situations where unsecured loans are ideal:
Covering unexpected expenses: If you have to meet a sudden cost, an unsecured loan gives you quick access to funding when you need it.
Launching a marketing campaign: An unsecured loan offers flexible funding to ramp up your marketing efforts without touching your cash flow or other finance facilities.
Bridging cash flow gaps: Unsecured loans are a good option when you don’t need a large amount of money, such as managing cash flow during a lean period or funding a new project.
Funding early-stage growth: Startups can tap into unsecured loans to cover essential early costs, like product development or hiring key talent, so they can get off the ground.
Pros and Cons of Unsecured Business Loans
Unsecured business loans offer a different set of advantages and risks compared to secured loans. Here’s what you need to know.
The pros of unsecured business loans are:
No collateral required: You don’t have to risk losing your assets if things don’t go as planned.
Fast approval process: Loan applications are often approved very quickly, which helps if you need funding right away.
Less paperwork: The application process is much simpler because there are fewer forms to fill in and no collateral to value.
Flexible use of funds: You can typically use the money for whatever you want, which means you have complete control over how you spend it.
Good for smaller funding needs: Unsecured loans are ideal for short-term, smaller financial requirements where you can repay the money faster.
The cons of secured business loans are:
Higher interest rates: Lenders take on more risk because you’re not offering them collateral, which means you’ll pay more in the long run.
Strict credit requirements: Lenders will review your credit history closely and are more likely to turn you down if your business or personal credit score is low.
Smaller loan amounts: These loans usually come with lower borrowing limits compared, so they may not be able to fund larger projects
A personal guarantee may be needed: You might have to provide a guarantee to your lender, which puts your personal assets at risk if your business can’t repay the loan.
Shorter repayment terms: These loans often have shorter repayment periods, which can mean higher monthly payments.
Should You Get Small Business Loans That Are Secured or Unsecured?
Whether you should get a small business loan that is secured or unsecured depends on the financing options of your startup or small business.
If you have bad credit, it might be easier to get a secured loan, especially if you have a lot of business or personal assets to put up as collateral. If you want better loan terms, putting up collateral can lower your interest rates and expand the repayment period. And if you’re a new business, it might be easier to put up collateral and get a secured loan.
If you have good credit and are looking for a smaller loan amount, then an unsecured loan might be worth considering. This is also true if you don’t have a lot of collateral or don’t want to risk your business assets for a loan. However, you’ll still need a lien or personal guarantee in most cases.
No matter the type of loan, each lender will have different eligibility requirements and repayment terms, so consult the loan terms before sending in a loan application.
Grow Your Business With a Small Business Loan
Small business loans—whether secured or unsecured—can provide the support you need to grow your business, buy real estate, or boost inventory. These loans are designed to help you take the next step, whatever that might look like for your company.
Choosing the right loan depends on your specific business needs. If you have assets to use as collateral, a secured loan might be your best bet. On the other hand, if you want to avoid collateral and have a good credit history, an unsecured loan could be more suitable. Either way, it's crucial to weigh the pros and cons carefully.
Backd offers two main funding products to help meet your business needs:
Working capital advances: Get between $25,000 and $2 million with no collateral required. Use the funds for up to 18 months to cover cash flow gaps, buy equipment, and more. The application is simple and takes only about three minutes and utilizes a soft credit check.
Business line of credit: Access $50,000 to $750,000 in financing within 24 hours. Draw the funds whenever you need them with competitive terms.
Ready to grow your business? Apply now for a working capital advance or business line of credit with Backd.
