A business loan is a simple form of lending; in exchange for finance, you will pay interest on the loan without giving away any shares in your business. Repayments are usually made on a monthly basis via a fixed amount covering interest and capital.
Business Loans fall into two main categories; secured and unsecured. This naturally raises questions like what’s the difference between a secured small business loan and unsecured small business loan? What are the best unsecured loans? Are there different types of unsecured loans? What’s the difference between a secured and unsecured loan?
There are significant differences between the two types of loans, which are explained below.
What is a secured business loan?
A secured business loan is a funding solution where the lender takes a form of physical asset as collateral, which means that if the loan was to default, the lender has the ability to sell the asset to recoup the finance owing on the loan. Secured lending is easier for a business to receive compared to an unsecured loan as the risk exposure to the lender is greatly reduced.
The assets provided by the borrower for a commercial loan could be company assets such as business premise, machinery or stock. In some cases, the business owner may be asked to provide collateral in the form of a personal asset, such as a property. It is essentially a business loan secured against property.
As well a term loan, there are other secured finance products available to businesses, which differ depending on the type of asset that is being offered as security.
Asset Finance – raising finance against company assets such as plant, machinery or a commercial vehicle.
Invoice Finance – borrowing against a business’s receivables, i.e. the invoices due to be paid.
Property Finance – borrowing secured against a property. This can be to either finance a business, or, to assist with the development of the property, or to bridge the gap while long-term finance such as a mortgage is being arranged.
Commercial mortgage – a longer term financing option for businesses to use their trading premises as security to secure funds.
Advantages of a secured business loan
- A secured loan is usually less expensive than an unsecured loan as there is less risk to the lender
- A business can normally borrow more when collateral is provided
- Although still important to a lender’s decision, there is less emphasis on the credit rating when the loan is secured
- A borrower may receive a longer repayment term if it is a secured loan
- If a commercial asset is offered, there may be no requirement for a personal guarantee from company directors
- Secured business loans can be obtained for longer periods of time, often over 10 years
- Secured business loans may be provided on an interest only basis, giving the borrower more flexibility
Disadvantages of a secured business loan
- Depending on the asset, there can be a requirement for valuations to be completed, plus legal costs, which have to be paid upfront
- Whatever collateral is provided could be at risk if the business defaults on the loan
- It often takes longer for secured finance applications to be processed compared to an unsecured facility
- If the security is insufficient, the lender may request a personal guarantee
What is an unsecured business loan?
An unsecured loan is a funding solution where there is no requirement for any physical assets owned by the business or the business owner to be provided as collateral. Unsecured business finance is provided on the basis of the borrower’s creditworthiness and focuses more on the trading history and strength of the business as well as the personal guarantee rather than the strength of the asset.
As there is no tangible security being provided, the lender has no assets to call on if the debt was to default, therefore making the risk to the lender a lot greater than a secured loan. As the lender is taking on more risk, a higher interest rate is charged.
As well as an unsecured term loan, businesses have access to other unsecured working capital solutions including:
Merchant Cash Advance – this is an advance against a business’s future card takings.
Revolving Credit Facility – the facility is rolling and not fixed like a term loam. It is similar to an overdraft facility; the borrower is approved for an amount of finance, which can be used as and when required. The borrower only pays interest on the amount borrowed
Advantages of an unsecured business loan
- Borrowers can receive funds quickly as valuations aren’t necessary and the legal process is a lot simpler
- There is no threat of losing a business asset should the business experience financial difficulty and the loan defaults
Disadvantages of an unsecured business loan
- Due to higher risk to the lender, the cost to the borrower is greater
- The repayment terms are usually between 1 and 5 years
- Personal guarantees are likely to be requested from directors
- The underwriting process is likely to be more thorough
What is a Personal Guarantee?
A personal guarantee is an individual’s legal agreement to repay finance provided to a company. The individual takes personal responsibility to repay a debt if the company is unable to. Lenders may request a personal guarantee from company directors that are looking for an unsecured start-up business loan. This reduces the lenders level of risk when they are not taking collateral.
Unsecured vs secured – which is best for your business?
The decision as to whether a secured or an unsecured loan is best for your business depends on the situation of your business and what you are looking to achieve. If your business has assets and you’re looking to release some cash into the business, secured finance is an option. If you are looking for a small amount of finance relatively quickly, unsecured business funding may be the answer.
At Newable, we have a team of Finance Specialists who can talk through the options available to you to find the right solution for your business’s goals. Whatever your requirements are, we take the stress and hassle out of finding the right finance solution for your business.
Find out more about how Newable Finance can assist with your finance enquiry.
We can also help you in other areas of your business. Whether it be Money, Advice or Workspace, Newable provides the essential resources businesses need to take the next step.
Find out more about how Newable can help you and your business.