An unsecured business loan is a type of commercial funding where the loan is not backed by some form of collateral, such as property. By contrast, secured business loans are backed by assets which act as a guarantee for the loan and therefore could be repossessed in the event of a default. As unsecured loans are not guaranteed, they represent a higher risk for the lender and usually have higher interest rates and fees.
What is the difference between a secured and unsecured business loan?
Both are term loans, where the funds must be repaid over a given period time with interest.
With a secured loan, the funds are backed by the personal or commercial assets of the borrower. Usually, this will be in the form of property, but can also be vehicles or business equipment such as machinery. Should the borrower default on payment, there is a possibility that the collateral will be repossessed by the lender and sold to recoup the funds. As a result of the guarantee, the risks for the lender are lower. This means it can be a long-term loan (up to 30 years) with favourable interest rates and fees.
An unsecured business loan does not require collateral as security. A business will be assessed on their ability to repay the loan, usually based on their financial performance, such as sales and cash flow results / forecasts.
Instead of collateral, personal guarantees may be required meaning the borrower can be personally liable if the business cannot afford to repay the loan. Failure to repay could lead to debt collection, court orders and even bankruptcy.
The greater risk means that rates tend to be higher and loan terms are shorter. Unsecured loans range from around 3 months to a maximum of 5 years. Limits start as low as $1,000 up to $1m and are generally based on the turnover of the business applying.
Where to get an unsecured loan
Many small business owners are unable to get secured loans from traditional banks, as they do not possess the required collateral or lack suitable financial records or credit score.
Non-bank lenders and fintechs stepped in to fill a gap in the market by offering funding opportunities to businesses in these situations. Many banks now also offer unsecured loans, in addition to more traditional secured loans.
To apply for an unsecured business loan, a lender will want to know the following about your business:
- Your turnover - there will be a minimum requirement and the loan amount may be based on this
- Time in business - usually a minimum of 6 to 12 months
- Type of business - what is the structure? are you registered?
- Business premises - how long have you been leasing your current address?
- Your credit history - as well as any directors of the business
- They may also want to see a business plan, forecasts and your plans for the funds
Advantages and disadvantages of unsecured loans
|Less risk to the borrower - in the case of default, they won’t lose personal or commercial property||More risk to the lender - resulting in higher rates and fees|
|Often comes with lower rates than a business line of credit or credit card||Higher rates than a secured loan|
|Quicker application process - funds can be available in hours with less documentation||Less finance available - the amount loaned is often based on turnover|
|Increased flexibility - fewer limitations on how the funds can be used, may include a redraw facility or the option to repay early||Businesses with bad credit may struggle to get approval - there are types of loans suited to applicants with poor credit|
Things to consider when comparing unsecured business financing
- Loan amount - how much can you borrow?
- Turnaround time - how fast can you access the funds? Some lenders can have the cash with you in 24 hours with more lenient lending criteria
- Interest rate - is it fixed or variable?
- Repayment period - for how many months will you be repaying the loan? Make sure the repayment period matches the purpose of the loan
- Fees - it’s important to understand any hidden fees and charges, such as an application fee, monthly fee, direct debit charges or loan documentation fees
- Flexibility - does the loan have a redraw facility, can you change the payment dates or amounts, does it allow early repayment?
Who are unsecured and secured loans suited to?
|Unsecured loans are suitable for businesses who:||Secured loans are suitable for businesses who:|
|Cannot get approval for a secured loan||Are established with a financial track record|
|Need a quick cash injection||Want a larger sum for operational equipment, such machinery or vehicles|
|Want the flexibility of a shorter loan||Can make repayments over a longer period of time|
|Lack the collateral to get a secured loan||Have assets that can be used as collateral|
Other types of small business loans
Business line of credit
A revolving line of credit from which funds can be drawn down on continuously up to an agreed-upon limit. Repayments are more flexible than a fixed-term loan. Interest is often charged on the daily balance and fees apply.
Similar to a business overdraft, but it typically must be applied for separately and is available to bigger businesses.
Used for expected expenses such as payroll, stock and materials, as well as general working capital.
Like a business line of credit but comes attached to a regular business transaction account. A common source of funding for businesses. Transactions can still be made beyond the limit of the account up to an agreed amount. A flexible form of finance as cash can be drawn again and again without fixed repayments.
Used for short term working capital needs and unexpected expenses.
Business credit card
Like a regular credit card but used for business purposes. It is often used for small expenses and paid off within a short time-frame to avoid the high rates.
Not recommended for ongoing business expenses such as operations, payroll or stock.
A source of finance used by companies of all sizes to access cash early from their unpaid invoices. It can be a line of credit secured against invoices or a lump sum.
Types of invoice finance include; invoice factoring, where the invoices are sold to a factor, and invoice discounting, where the accounts receivable ledger is used as a guarantee for a line of credit or upfront funds.
Used to ease ongoing cash flow issues resulting from payment terms on invoices.