What Is an Unsecured Loan? A Short Guide for Businesses
When you’re seeking business financing, you may see funding options described as unsecured or secured. But you may wonder, “What is an unsecured loan, and how do these two loan types differ?” These answers can help you understand your options and which is best for you.
In this article, we’ll provide an answer to what an unsecured loan is. Plus, we’ll cover how the eligibility requirements differ between secured and unsecured loans, the types of business funding that are unsecured, and the steps of the application process.
What Is an Unsecured Loan?
An unsecured loan is a type of installment loan that doesn’t require the borrower to put up assets — like real estate or their accounts receivables — as collateral. Without the need for collateral, the borrower doesn’t have to risk the loss of a business or personal asset.
This is different from a secured loan, which is backed by collateral. The collateral serves to minimize the lender’s risk. For example, if you fail to make your repayments and default on a secured loan, the lender can take possession of your collateral in order to cover the amount you owe.
Even though you avoid the potential loss of collateral with an unsecured loan, there are still consequences to keep in mind if you miss payments or default on your loan. You can incur late payments, negative marks on your credit report, or have your account turned over to a collections agency.
The Eligibility Requirements of Unsecured Loans vs. Secured Loans
Other than not having to pledge collateral, there are a number of other differences between unsecured and secured loans when it comes to the eligibility and approval process.
Creditworthiness
Both secured and unsecured lenders will review credit reports from credit bureaus when they’re assessing a loan application. Borrower creditworthiness is more important, however, to unsecured lenders. The reason for this is risk.
As we’ve mentioned, with a secured business loan, your lender can sell the assets you’ve pledged as security if you default on the loan. The money they raise from the sale is used to reduce or pay off the remaining balance on the facility.
With an unsecured loan, the lender does not have this safety net. Therefore, most unsecured loan providers will only approve borrowers with a good credit rating or excellent credit rating.
Startups and companies with bad credit ratings are much more likely to have their applications declined, although they may have a better chance if they pursue an SBA loan.
Credit Limits
Loan amounts offered to borrowers on secured loan facilities can be much greater in size than those offered on unsecured loans.
Again, that’s because the lender’s who secure a loan with collateral stand to lose much less money if you default on your loan. A secured lender’s loan offer may extend to the full value of the assets you’ve pledged.
On unsecured loans, the maximum loan amount is determined by your creditworthiness and your company’s ability to repay the facility.
Cost of Capital
Unsecured loan interest rates can be substantially higher than interest rates offered on secured loans.
The reason lenders charge lower interest rates on secured loans is also related to the lower risk of losing money if you default.
However, some lenders of unsecured loans will offer an interest rate discount if you agree to have your monthly payments automatically withdrawn from your checking account. This can help offset some of their risk by giving them a better chance of receiving payment.
Repayment Terms
In addition to higher interest rates, lenders offer much shorter repayment windows on unsecured loans.
This is because borrowers default less on secured debt than they do on unsecured debt. Lenders believe that the longer the repayment window, the greater the risk that, during the term, market conditions could deteriorate, affecting a borrower’s ability to make their payments.
Approval Process
An application for an unsecured loan is likely to be turned around much faster than with a secured loan.
The reason for this is, with a secured loan, there is more paperwork to complete and review. The lender sometimes has to instruct a surveyor to value your assets, and there is also a need to complete legal documents that give them title over the collateral in case you default.
Unsecured loan lenders don’t have to take these additional steps. This means that they can make quicker decisions so borrowers can receive their capital much faster.
Examples of Unsecured Loans You Can Apply For
Common types of unsecured loans for businesses include:
Standard business loan: Many banks, credit unions, and online lenders advance cash to firms to help them expand, invest in new equipment, purchase inventory, and so on.
Business line of credit: A business line of credit is a flexible loan that allows companies to borrow up to a certain limit and only pay interest on the amount they’ve borrowed.
Merchant cash advance (MCA): An MCA is short-term financing that is secured on future debit and credit card transactions.
Working capital advance: Working capital advances allows companies to cover their day-to-day operational expenses, like meeting payroll or rent, when cash flow is challenging.
How to Apply for an Unsecured Business Loan
To apply for an unsecured business loan, follow these steps:
Decide how much you need: Don’t borrow more than you need to. Work out exactly how much you need to borrow and how much of a monthly payment you can afford and/or how quickly you’ll be able to pay the money back.
Search for a lender: Most traditional banks and credit unions offer unsecured loans. But there are many online lenders and brokers you can consider as well.
Complete your loan application form: Share all the information your lender requires to process your application. If you submit an incomplete application form, this will result in delayed funding. Many lenders now allow you to apply online or via a smartphone app.
Submit your supporting documentation: The lender you approach may need you to submit bank account and savings account statements, profit and loss forecasts, and other documentation. This is so they can check that you’ll be able to make the repayments.
Wait for an answer: The lender’s underwriting team will now assess your creditworthiness, focusing on factors like your credit history, debt-to-income ratio (DTI), history of missed payments, and cash flow stability. How long you’ll have to wait for an approval will vary by lender, but some online lenders can get you a response within 24 hours.
Consider the terms: If your lender approves your application, they will then present you with your loan terms. Their offer letter or email will contain the annual percentage rate (APR), your monthly loan payment amounts, agreement end date, and more. Also, be sure to understand what kind of fees will accompany your loan, such as a loan origination fee. Once you accept the terms, you will receive the funds.
Explore Different Commercial Funding Options With Backd
With a good credit score and solid company financials, you have a great chance of qualifying for an unsecured loan by applying directly with a lender or via a broker. Although you may have to pay higher interest charges than with a secured loan, you won’t be putting your physical and other assets at risk in the event that you default.
Backd offers two market-leading unsecured finance facilities to businesses:
Working capital advance: Borrow from $25,000 to $2 million over a period of up to 16 months.
Business line of credit: Access $25,000 to $750,000 and repay weekly over six or 12 months.
Apply for funding today with Backd and receive funds in as little as 24 hours.
