Is a Small Business Loan Secured or Unsecured?

As a small business owner, if you’re looking to grow your business or fund a startup, a small business loan may help you. There are two types of business loans to choose from: a secured business loan and an unsecured business loan.

While each offers its own benefits, there are quite a few differences between secured and unsecured business loans, like the application process, loan terms, loan amounts and lender requirements. And because there’s more risk for the lender with unsecured loans, small businesses that are just starting out may find it harder to qualify for them.

You can get small business loans from banks, credit unions and online lenders. Some loans are backed by the Small Business Administration (SBA), which helps small businesses get funding by setting loan guidelines and providing loan guarantees for lenders.

The type of loan you choose will determine loan terms and affect your business and finances differently. So let’s take a look at the differences between secured and unsecured loans so you can decide which option is best for your business.

Secured Small Business Loans

A secured small business loan is a loan that uses assets as collateral, providing security for the lender to recoup their losses if you default on the loan. Because the loan is backed by collateral, interest rates for secured loans are usually lower than for unsecured loans.

How does a secured loan work?

During the loan application process, you identify the assets to be used as collateral. What your lender deems as qualifying collateral will depend on the lender, the loan you’re applying for and your financial situation. The lender may accept assets such as land, business bank accounts, inventory, equipment and property. The key is that you must own the assets.

The value of the assets will help determine how much money you can borrow. The more valuable your assets, the more money you may be able to borrow. This is why secured loans generally have higher borrowing limits. Because the assets have to go through a valuation process, it can take longer to get a secured loan than an unsecured loan. If approved, you will receive the money in a lump sum.

If you default on the loan, the lender may be able to take the assets outlined in your loan contract to repay the debt.

Can you get a secured loan?

Most of the time, if your business owns high-value assets and has strong financials, you’ll qualify for a secured loan.

Let’s take a closer look at what lenders will review to determine if you qualify for a secured loan:

• Assets: Owning high-value assets to use as collateral looks good to lenders. They’ll likely lend you more because you “guarantee” they’ll get their money back if you default.
• Revenue: Having healthy revenue and profits shows your business is less at risk of cash flow problems, meaning you’re more likely to repay the loan.
• Credit: Your personal and business credit scores are considered during the application process. Having higher credit scores is favorable, but because the loan is backed by collateral, your credit scores are less impactful than they are for unsecured loans.

Unsecured Small Business Loans

An unsecured small business loan is a loan that is not backed by collateral. A lender will assume more risk with these loans since there’s no security or “guarantee” they’ll recoup their losses if you default. For this reason, interest rates are usually higher for unsecured loans than for secured loans.

Since unsecured loans aren’t backed by collateral, lenders tend to place limits on borrowing, so smaller loan amounts are often easier to qualify for. Unlike secured loans, you may be able to get funding faster because there’s no valuation process.

How does an unsecured loan work?

During the loan application process, a lender will look at your personal and business finances to see if you qualify for your requested loan amount. Each lender has their own requirements, so make sure you’re aware of them before applying.

If the lender determines that you qualify for the loan, you will either receive the amount in a lump sum or the lender will ask for more security before extending financing. This is where a blanket lien or a personal guarantee can come into play.

The blanket lien

A blanket lien is an agreement between the lender and borrower that states the lender can take assets as collateral if the borrower defaults. It’s essentially a way to secure an unsecured loan. But you don’t get to define which assets the lender can take. They will take possession of whatever assets are needed to cover the loan.

The personal guarantee

Another way for a lender to obtain security with an unsecured loan is by requiring a personal guarantee. This is an agreement in which an individual promises to be personally responsible for repaying the loan if the business can’t.

Can you get an unsecured loan?

With unsecured loans, both your personal and business credit profiles and business revenue, directly determine if you qualify for the loan.

Let’s take a closer look:

• Revenue: Having healthy revenue and profits shows your business is less at risk of cash flow problems, meaning you’re more likely to repay the loan.
• Credit: Your personal and business credit scores are considered during the application process. Because there’s no collateral backing this loan, credit is important. It’s more difficult for a small business without an established credit history or poor credit to qualify for a loan.
• Business plan: Providing a lender with a solid plan for your business – instead of a risky plan or no plan – can make you seem like less of a liability.

Types of Business Loans and Financing Options

There are many business loan and financing options available to small businesses, both secured and unsecured. The type you choose will depend on your situation. Let’s take a look at some of them.

Business term loans

Term loan is an umbrella term for secured and unsecured business loans that are delivered in a lump sum and repaid over a fixed payment schedule. Car loans, student loans and mortgages operate this way. The interest rates are usually fixed but can vary based on the lender and loan type. Depending on the loan, you may be able to receive up to $5 million in funding.

Business line of credit

Unlike a loan, a business line of credit works more like a credit card. You get access to a revolving line of credit with a set limit. You only pay interest on what you borrow against the line of credit.

This is a more flexible option than a loan because you can use it whenever you need it. Much like a credit card, the credit you use becomes unavailable until you pay it back. As long as you continue to make payments, you can continue to draw from your line of credit. Credit limits are usually lower than what you’d be able to borrow with a loan, so keep that in mind.

Small Business Administration (SBA) loans

As we briefly mentioned, some loans are backed by the SBA and are great for small businesses that are starting or expanding. There are a variety of SBA loans to choose from based on your size, revenue and goals. Loan terms for SBA loans are usually more competitive than those not backed by the SBA, and some loans even come with business counseling. You can get anywhere from $500 to $5.5 million.

Equipment financing

This is a type of business loan that is used specifically to purchase equipment for your business. With this option, the equipment you’re financing is used as collateral. You may be able to qualify with poor credit, but the lender will still require a credit check.

You may be able to finance up to 100% of the value of the equipment, and some lenders will finance other added costs like warranties, delivery and installation. Repayment terms are usually based on the life expectancy of the equipment.

Inventory financing

This is a short-term loan or line of credit that allows you to purchase inventory for your business. It works similarly to equipment financing in that the loan, or line of credit, is based on the value of the inventory, which is used as collateral. You may be able to receive financing without a credit check.

This may be a good option for a business that pays suppliers for goods that are held in a warehouse to sell at a later date or for businesses that have seasonal fluctuations in demand. Because inventory depreciates over time and there’s no guarantee a business would be able to sell it, lenders aren’t as willing to finance the inventory’s full value.

Invoice financing

This type of short-term loan is a way for businesses to borrow money against outstanding customer invoices. With this option, invoices are the collateral. You may be able to receive financing without a credit check.

If you have a business that sells products or services not paid in full, this can be a way to continue paying suppliers, employees and other business expenses while waiting on amounts due from customers. Usually, lenders won’t finance 100% of the value of the unpaid invoices to limit their risk in case the customer never pays. Despite any unpaid invoices, the business is still responsible for repaying the loan. This is unlike invoice factoring, where the lender takes over collecting funds from the customer.

Should Your Small Business Loan Be Secured or Unsecured?

You’ll have to look at your situation to decide which loan is best for you, but we’ve laid out a couple of scenarios to help you decide.

A secured loan might be a good option if you don’t have decent cash flow, but have assets to help you get a higher loan amount. The application process for secured loans is usually longer than for unsecured loans, but interest rates are usually lower and your credit profile isn’t as highly scrutinized.

An unsecured loan might be a good option if you need a smaller loan amount, are in a good financial situation but don’t have a lot of assets. You don’t need to have collateral to qualify for this loan, but you may have to provide a personal guarantee, assuming responsibility if the business can’t repay the loan.

If you find you don’t qualify for a business loan, you may be able to get a personal loan and use it for your small business.

Take On a Loan That’s Right for Your Small Business

No matter which loan you decide to apply for, financing can help you start or grow your small business.

Just make sure you understand what you’re responsible for and what may be at risk if you can’t repay your loan.