To get a new business off the ground requires funding, which in most cases involves financing from a lender. Approach a bank, and you’re usually given two main options: a secured loan and an unsecured loan. But which one is best for your business?
Both options have their place in modern business, but it’s important that you choose the best lending option for your circumstances. Select the loan that suits your business plan, your financial circumstances and your plans for the future.
Here’s a rundown of both to help you decide.
What Is a Secured Loan?
Secured loans are processed against collateral, such as a property or a company. The lender knows that the value of the loan is covered by the asset, so the amounts on offer tend to be relatively high. In return for this lower risk, you might be offered a low-interest rate too.
While you can get your hands on large amounts of cheap money with a secured loan, they are very risky. If you fall behind with your payments, the asset you’ve provided as collateral can be seized relatively easily in order to pay off your loan. If there’s a shortfall, you’re still liable for it. However, if your asset is worth more than the total amount you owe, you receive the difference once it has been sold.
What Is an Unsecured Loan?
Unsecured loans are far simpler and quicker to process. You simply borrow money from a bank at a specific rate of interest. No collateral is required, which means the risk to the lender is greater. As a result, the interest rates associated with unsecured loans are usually significantly higher. You or your business must demonstrate a history of repaying debt on time and in full to qualify.
Reasons a Secured Loan Might Be the Best Option
If you need a large capital injection for expansion, capital for purchase order financing, or the purchase of expensive industrial equipment, the chances are you’ll need a secured loan. Unsecured loans probably may not provide you with enough cash, depending on your plans.
The secured route might also be the best option if you have a long-term plan for growth and re-investment. Typically, lenders give you far longer to repay a secured loan, which minimizes your monthly payments and frees up cash to grow your business. Of course, it might be in your company’s best interest to pay off loans quickly — perhaps if you have plans to sell the business in the near future.
If you don’t have a particularly high credit rating, or if your business doesn’t have a significant trading history, you might struggle to get approved for unsecured loans. And if you can find a lender willing to provide you with such a loan product, you’ll probably pay a high interest rate.
The Disadvantages of Secured Loans
The obvious drawback is the risk of losing your asset — usually your home. If you miss just one or two payments, your property might be in jeopardy. Also, be aware late payment charges are added to arrears, which can speed up the process.
You might need to pay upfront arrangement fees and other charges just to apply for a secured loan. This won’t be ideal if you need every penny for investment in your company. And the application process involves presenting official documents to prove ownership of the assets. This is not ideal if the cash injection you need for your business is urgent.
Reasons an Unsecured Loan Might Be the Best Option
There may be occasions when an unsecured loan is best for your business. For example, you can choose to lend smaller amounts, meaning you don’t take on expensive debt that you just don’t need. Secured loans are usually available at relatively high minimum amounts.
Unsecured loans also tend to be a little more flexible. This can be great if your business income is unpredictable. Most providers give you up to five years to repay your loan. However, there are plans that last just a year. And, in most cases, applications for unsecured loans are processed much faster than loans involving collateral.
If your company has been trading for at least three years, you may not need to use your own property as collateral. Lenders will assess your trading records and make a decision based on your business’ ability to keep up with repayments. Cash flow, credit history, cash reserves and balance sheets will all work in your favor. This is great news if your only major asset is your home.
The Disadvantages of Unsecured Loans
Unsecured loans are riskier for lenders, so approvals are less likely. If you need a cash injection quickly, the last thing you want is to waste time on an unsuccessful application. If you don’t have trading records and a good credit rating, don’t apply for this type of financing. Unsecured loans are relatively small, so they may not cover startup costs and expensive capital purchases.
Carefully consider your personal situation, your business’ requirements and your credit history before you decide whether to choose a secured or unsecured business loan. Also, look beyond traditional lenders and banks, because today, there are many alternatives to choose from.
Think creatively about the type of funding you might find. For example, if you’re a female entrepreneur, there are many special grants and loans for women-owned businesses that you can pursue. If you’re interested in fast funding from alternative sources, there are an increasing number of fintech firms devoted to making access to small business credit easier.
Alternative sources of financing are becoming increasingly popular among startups and entrepreneurs — and they often a lot more flexible with their approach to assessing applications. Depending on your stage of growth and how fast you need funds, a fintech lender might be the answer to your financing requirements.
Disclaimer: Fundbox and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.