Secured vs Unsecured Small Business Loans

The key to a successful business is timely financing. It takes a lot of money and effort before a new business starts to make a profit. To date, more than 30 million small companies are registered in the United States. And Over 627,000 new startups are being opened every year. Every third American family is engaged in a small business. In general, companies with up to 100 employees provide jobs for more than half of the US working population.

Some American business textbooks claim that up to 20% of US small firms start at $ 1,000–5,000. And more than half of them in less than 2–3 years move to the ranks of companies with annual revenues of more than $ 1 million.

US small business financing is carried out mainly from two sources: through the Small Business Administration (SBA) and through commercial banks. The largest share of loans is issued by the Small Business Administration.

According to SBA, commercial and industrial mortgage loans amounted to more than $ 1 billion. Total loans for small businesses for the year approached $ 1 trillion. Loans up to $ 250 thousand make nearly $ 188 billion, and loans up to 100 thousand dollars sum up to 112 billion dollars.

Business credit can be the key to success, but lending is always a risk. We will tell you how to find the best financing for your project and protect your assets.

Choosing a Financing Method

Your business may need financing at different stages of its existence. The funds are usually required for expanding the current company or purchasing new assets. There are many sources offering business loans but how to choose the most appropriate one for your needs? These hints will clarify it.

  • The business line of credit. This credit option is best for recharging working capital. It differs from a regular business loan. When you take a usual business loan, you are to pay a monthly payment to cover the received funds. A business line of credit needs to be repaid only when you use some money. The business owner can decide when and how much he wants to use the approved amount. There is also a repayment period, but you may pay back earlier.
  • It is a business loan allowing you to withdraw an amount exceeding the balance on your account. This loan gives you flexibility in your cash flow simplifying the current payment with suppliers, contractors, etc.
  • Term loan for 1-3 years is a good option to expand your small business.
  • Investment loans for a period of 5-7 years should be considered for the purchase of equipment, machinery, materials.
  • Investment loan for 5-10 years is good for the purchase of real estate.
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Loan Types

Banks offer two main forms of credits: secured and unsecured loans. It is vital to realize the difference between these two notions to maintain your financial state safe. These two types of loans imply different interests and terms of repayment.

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An unsecured loan is faster to obtain but you must be prepared to pay more.

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What is a Secured Loan? and What are the Main Things to Know About a Secured Loan?

A secured loan always requires collateral or other assets as a guarantee to the lending institution that you will pay off the borrowed funds.

Secured loan is always backed up by some kind of asset, also known as “collateral”. Collateral may be property, car, or other valuable belongings such as stocks or bonds. Some lenders may accept collateral in the form of a savings account and in even such items of value like jewelry. Collateral for your secured loan can take the form of the item you are purchasing, such as the equipment or property relevant to your business. Often, a home may serve as collateral because lenders realize that you, as a business owner, will generally do whatever is necessary to maintain your home.

secured vs unsecured

The lender uses collateral as a security if you fail to repay back the borrowed funds. Collateral enables you to receive a large sum of money for your needs. But at the same time, you put your property at risk. The lender will sell your collateral in case you cannot repay a secured loan.

The collateral value must equate at least the value of the loan. In some circumstances, lenders may ask for the collateral to exceed the amount of the loan because certain types of collateral, such as real estate, require considerable time and effort to turn into cash.

For example, if you used a home as collateral and then defaulted on the loan, the lender would try to sell the house, which would require them to jump through various hoops. After the asset is sold, the lender will take enough money to cover the amount you owe, plus the expenses incurred during the sale of the asset and then give you the rest.

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Examples of Secured Loans:

  • Mortgages – These loans for property or real estate are backed with the property itself.
  • Construction loan – This is a short-term loan used to fund the building of a house or another real estate project and is backed with the property.
  • Car loans – Many people opt to finance their car, which means taking out an auto loan to buy their new or pre-owned vehicle, and then paying back the loan with interest over time. These loans are useful when making a purchase of a major vehicle, and are secured with the vehicle.
  • Secured Credit Cards – Secured credit cards require account holders to provide a refundable security deposit in exchange for a line of credit.
  • Home equity line of credit -This is another kind of loan that you can back with your home. A home equity line of credit, also known as a HELOC, is a line of credit backed by your house that allows you a revolving credit line for your expenses or to consolidate other loans that bear higher-interest rate.
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The advantages of the secured loans:

  • Easily available – Secured loans are easily available relative to unsecured loans. The process of secured loans is smooth and straightforward because the lender has a reasonable assurance of his money.
  • Affordable interest rate – The borrower pays an affordable interest rate as the loan is backed up and lenders financial risk is rather low;
  • Borrowing big amounts – Secured loans allow to receive large sums of money as thanks to collateral lenders are confident they will not lose their money;
  • Tax incentives – Some secured loans are accompanied by tax incentives
  • Remain in the discipline of repayment – This type of loan is usually repaid on a monthly basis. But it is important to carefully check the amount to be settled each month will as the interest rate varies in various lending institutions.
  • Doesn’t require high credit score – The borrower does not necessarily need to have a high credit score to be eligible for a secured loan.
  • Build credit score – Secured loans are a great way of building a credit score. The information about taking this loan goes to the credit bureau and in the event that the loan is successfully paid your credit score is strengthened.
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Drawbacks of the secured loans:

  • you’re personally liable for the money you’ve borrowed – Providing collateral, you put your property and other assets at risk in case if you cannot maintain repayments.
  • Sometimes lenders offer a tricky system of interest rates, meaning your monthly payments could grow. Before taking a load, you should carefully study all the conditions and check whether the rate is fixed or variable.
  • If you wish to repay your secured loan earlier, lenders usually will impose an early repayment fee. Do not forget to recheck it in advance.

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When Should You Apply for a Secured Loan?

This type of loan is a good option when you need a considerable amount of money and have assets to protect it. The lender will ask to provide collateral to secure the borrowed sum. This is an official document that guarantees that you are ready to give your property or other assets to the lender in case you fail to pay back the money. But you will enjoy paying less interest rate.

secured and unsecured business loan

With a secured loan you may obtain a considerable sum of money to finance various costly projects.

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Unsecured Loans and Key Things to Know

An unsecured loan is only backed by the creditworthiness of the borrower, rather than by any collateral, such as real estate and other properties. You do not need to back up this type of loan. However, an unsecured loan is given on the basis of your ability to repay the loan. You will not need collateral but you must have a reliable credit score.

credit debt unsecured business

Every borrower will be asked to provide a package of documents with the information about his employment, credit history, savings. You may receive unsecured loans in the form of a credit card, student loan, or personal loan. Besides, you should be prepared to pay a high interest rate.

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Examples of Unsecured Loans:

  • The most common example of unsecured lending instruments is credit cards. Even though you might not think of credit cards as loans, you borrow money when you spend with a credit card. Every time you pay for something with a credit card backed by a financial institution, that institution is really giving you an unsecured loan, on the spot.
  • Signature loans – This is a type of personal loan offered by banks and other finance institutions that only requires the borrower’s signature and a promise to pay as collateral. You can be eligible to get a ‘signature loan’ when you have a good relationship with a bank. This is an unsecured loan which is founded on good faith evaluation of the character of the borrower and promises to pay back the funds.
  • Student loans. While these don’t necessarily relate to your small business funding, student loans are a good example of unsecured loans. Private student loans and student loans through the Department of Education are typically unsecured. While students do not have to provide any collateral to get a student loan, in the event that they do not meet their loan payments they do risk things like garnished tax refunds or income in the future if they are unable to make their loan payments.
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Advantages of Unsecured Loans

  • Possibility to get money without any guarantee, it means you do not risk your property;
  • Unsecured loan approval is much faster as no time is required for assets evaluation; Sometimes you get money on the same day you apply for a loan;
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Disadvantages of Unsecured Loans

  • You will be able to get limited funds only. Lending institutions do not give large sums of money without backing up;
  • It is very expensive. As you do not need collateral for an unsecured loan, lenders protect themselves by high interest rates. The rate will be even higher for a borrower with a low credit score.
  • Lenders will not be able to take your property in case you have financial difficulties and are not able to pay in time. But they have other methods of influence to get money back. One of them is a report to the credit bureau and a negative result on your credit score.
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When Unsecured Loans Are the Best Option?

The most attractive thing about an unsecured loan is its fast approval. Besides, the amount of documents is much less than you need for other types of credit. Though, these loans are not so easy to obtain. To successfully obtain the unsecured loan, you must provide proof of perfect credit history to be given funds without any collateral. Another important thing to remember is a higher interest you will have to pay. But in the following cases the unsecured loans may be the best way to get financial assistance:

  • Buying a car. With unsecured car loans, you considerably win time. And the interest rates are rather competitive;
  • Home renovation. Time is precious when you are refurbishing your accommodation. The unsecured loan will enable you to complete your project faster if you suddenly go beyond the planned budget;
  • Medical bills can also be settled with unsecured loans as well as tuition fees;
  • Consolidation of outstanding debts. An unsecured loan can be one of the options to pay off accumulated financial liabilities.

saving money

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Secured vs Unsecured Loans – What Loan to Choose?

Here you will have to analyze a number of factors: the sum you are going to borrow, your credit history and score, and your readiness to risk. You should always picture the worst scenario of your loan and see what you may lose at the end. Of source, a secured loan is cheaper and easier to obtain, but you should not underestimate the risk of losing the property.

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Secured vs Unsecured Loans Point of Differences

Points of Differences Secured Loans Unsecured Loans
Security An asset placed as collateral security. The loan is completely based on the borrower’s credit.
Interest The risk to lender’s money is low (loan is backed by the collateral), the interest cost is also lower here. The risk perception in unsecured loans is high, hence the interest rate is higher as well.
Availability to Borrower Secured loans are easy to borrow. There is no need to convince the lender too much on parameters when security is available. Unsecured loans are not easily available to all. The lenders conduct a rigorous credit check before extending the loan.
Processing Processing the papers and evaluating the real worth of the collateral may take some time. The processing time increases when making a decision about whether or not to extend the loan.
Credit Score A lower credit score will suffice when you have collateral to offer for a secured loan. You should have a very good track record and reasonable credit score.
Suitable for Due to the lower interest rates, the cost of funds may be on lower side and the loan is suitable for long term needs. Suitable for a temporary unavoidable need for money because these loans are very costly.
Size of Loan All sizes of loans are available as secured loans. Big size loans are not lent as unsecured loans. Only small and medium-sized loans are extended as unsecured loans.
Secured vs. Unsecured Loans: Which Loan Should I Pay Down First?

As discussed above, secured loans often come with lower interest rates than unsecured debt, because the lender has something of value to take if bills go unpaid. Let’s assume that you have 2 loans – an auto loan and a large amount of credit card debt, and you can’t afford to pay both. On the one hand, you should prioritize the secured debt (auto loan), because if you don’t pay it, you’ll lose your car, which might prevent you from getting to work, jeopardize you’re your income and your ability to pay your bills. However, if you can afford your debt payments but just want to get rid of one of them, the opposite strategy makes most sense and you should target the unsecured debt because it generally has higher interest rates.

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