What is an unsecured business loan?
As a small business owner, chances are you will need additional funding to cover start-up costs, hire more employees, purchase additional inventory, or cover other monetary needs.
According to Small Business Profile 2019 published by the US Small Business Administration Office of Advocacy, approximately 6.1 million loans worth less than $ 100,000 have been made to small businesses by US lending institutions. Likewise, the Federal Reserve Small Business Credit Survey 2018 estimated that about 71% of the 12,000 small businesses surveyed sought financing of $ 100,000 or less, with loans or lines of credit being the most common form of financing.
Lenders generally offer two main types of financing: secured loans and unsecured loans. But what type of loan is right for your business? Understanding the main differences between the two could mean the difference between a safe injection of cash and a costly financial miscalculation.
What is an unsecured business loan?
The biggest difference between secure and unsecured business loans is that the latter does not require the borrower to provide security against the amount he borrows. In fact, Jeff Fazio, chief of small business specialists at TD Bank, has said that this type of loan is “strictly guaranteed by the creditworthiness of the borrower.”
“Small businesses usually look for an unsecured loan when they cannot or cannot qualify for a traditional loan. negotiate better repayment terms with another lender, ”Fazio said. “The personal collateral terms described in unsecured loans can be very generous to borrowers, but any default can have long-term ramifications that outweigh the benefits, such as negative effects on credit score. of your company.
Because an unsecured business loan is better for the borrower, the lender typically charges much higher interest rates than they would for a loan. backed by guarantees. This type of loan is also much more difficult to obtain as a result. The risk inherent in an unsecured business loan naturally means that it will usually be offered as a short term loan to mitigate the risk of the lender.
To qualify for an unsecured business loan, according to Fazio, your small business must be able to “show the lender a good credit rating, a solid financial history, and a cash flow forecast.” He pointed out that it is rare for a traditional lender to approve an unsecured loan, with most of these types of loan agreements coming from online lenders.
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If your business has enough financial goodwill in the form of a strong credit rating and you can afford the interest rates, there are some advantages to getting an unsecured business loan.
The first and most immediately apparent benefit is that you don’t need collateral. Usually, lenders want borrowers to put up valuable items such as real estate, vehicles or intangible assets such as investment portfolios and trademarks as collateral for the loan. Without needing to put these items at risk of seizure by the lending institution, you can rest easy knowing that you won’t lose them if something goes wrong.
However, the objects can eventually be seized by the lender if they are included in the personal guarantee that each lender must sign for an unsecured business loan. Such an agreement is legally binding, after all.
Unsecured business loans generally require less paperwork, bypass the process of appraising any collateral, and therefore have a faster process overall. Unsecured business loans are also canceled if your business goes bankrupt, while secured business loans do not. [Read Related: How to Choose a Loan Provider]
Risks Associated With Unsecured Small Business Loans
While the benefits may sound great, there are some important caveats to consider when looking for an unsecured business loan. First and foremost, you can’t even benefit from it.
Banks rely heavily on your personal or business credit score to determine whether they are willing to offer you any type of loan, but given the high risk nature of unsecured business loans, the bar is set much higher. While there is no minimum credit score you need for a short term business loan like this, a lower credit score tells the lender that you may have a harder time paying off the loan. ready.
If your personal credit isn’t good, if your business has a less than stellar credit history, or if your bad credit regularly prevents you from getting a credit card, let alone some other type of cash advance, your loan application is unlikely to be successful. you have all the additional business funding opportunities anyway. It will always be more difficult to borrow money if you are having trouble making your monthly payments. [Read Related: Small Business Loan vs. Cash Advance]
If your business needs a large amount of funds, you probably won’t be able to get as much as you need with an unsecured loan, which usually only offers smaller amounts. Again, because there is no collateral to back the loan, banks are less inclined to take risks and provide large sums of money.
Additionally, an unsecured business loan may not be right for you simply because of the significant rise in interest rates for this type of loan. The rates are almost always higher than some major credit cards, with some lenders charging 100% APR. The height of this figure depends on your credit score.
“Since a lender takes more risk in providing an unsecured loan, interest rates are high for borrowers,” Fazio said. “With unsecured business loans, we often find that the borrower may default and not be able to afford to repay the loan.”
That brings us to the bigger warning, which should really apply to any borrowing you are considering – defaulting on an unsecured loan means big problems for you and your business. Even if you don’t provide any collateral, which minimizes the risk to the lender, there are other ways that failing to repay your loan could cause you major financial problems.
If you default on an unsecured business loan, your personal credit score and that of your business will take a big hit. Also, just because you couldn’t stand specific the guarantee does not mean that you will not lose any assets. The lender can sue you and your business not only for the loan balance, but also for interest and other charges. Your company bank accounts can be garnished, privileges can be placed on the assets of your company, and whatever can happen in months.