Secured Business Loans vs. Unsecured Business Loans

So you've already come up with a great business idea? You're probably working out the kinks of day-to-day operations, but you've probably been wondering what it takes to get a loan.

When you finish this article, you'll know the difference between an unsecured loan and a secured loan and which to go with.

What Is an Unsecured Business Loan?

An unsecured business loan is based solely on an individual's financial integrity, business record, and character within the community. Based on these aspects, a lender may decide to provide a loan to an individual without requiring any collateral if they are in good standing.

In order to obtain an unsecured loan, a business owner must have very good records and a great reputation within the business world. Because of this, unsecured business loans are often called "signature loans".

With essentially a signature and good credit, you can attain an unsecured business loan.

Because an unsecured loan does not require any collateral, there are much higher interest rates associated with them.

Lenders do this to provide some form of protection for themselves in case the loan defaults. With higher interest rates, the lender gets some sort of profit off of the loan that can make up for collateral as a cushion.

Interest rates vary as the market fluctuates, but as a business owner, you can plan on a substantially higher rate than a secured loan would have.

Unsecured loans are a lot like credit cards in this way-credit cards do not require any collateral when you sign up for them. The lender assumes, based on your current and past credit, that you will be able to pay the loans back.

The most obvious benefit of getting an unsecured business loan is the fact that you do not have to provide collateral.

Your business assets are protected from being seized in the circumstance of a default on the loan. This is especially beneficial if you do not have a lot of business collateral to pledge.

For example, your business may not be based on manufacturing physical products that you could provide as collateral, as well as the equipment to produce these goods and you would be forced to use personal collateral instead of just business collateral.

Even though there are benefits for an unsecured loan, there are understandably some disadvantages as well. One of those disadvantages is that an unsecured loan is more difficult to obtain than a secured loan if you have poor credit.

When a lender agrees to give you an unsecured loan, they are taking a huge risk on you. Therefore, their qualification terms are going to be more difficult to meet.

Another large disadvantage, as before mentioned, is the interest rates associated with unsecured loans.

When all is said and done, you will end up spending considerably more on an unsecured loan over the lifespan of the loan than on a secured loan.

What Is a Secured Business Loan?

A secured loan is a loan in which collateral is provided in order to secure the loan. The purpose behind this is to provide protection for the lender in case the loan defaults.

In the case of a default, the lender can appropriate the collateral pledged.

As always, there are different advantages and disadvantages to different kinds of loans.

One of the advantages of a secured loan is that because collateral is pledged, interest rates on the loan are lower. The risk of lending to you is lower when you provide collateral because the lender can obtain the worth of what they lent to you through that collateral, either by keeping it or selling it.

The lower interest rate means that you will pay less over the lifespan of the loan, and if you pay it off in a timely manner, you won't have to worry about surrendering your assets.

Another advantage of a secured loan is that you will be able to get a loan of greater worth versus if it was unsecured. Lenders are willing to put more money towards secured loans because they are less risky. This is especially true if you have good credit as well as collateral.

The combination of the two is a great reassurance to the creditor that you are a good investment who will pay back the loan.

Good credit in secured loans is definitely in your favor, but it is not as crucial as in unsecured loans. Because you pledge collateral, the creditor will care less about your credit.

This is especially beneficial to newer companies and business owners who haven't had the time to build up the business credit that is important in the eyes of creditors when securing business loans.

One disadvantage of a secured business is, understandably, that you as a business owner have to provide collateral.

This can be tricky in businesses that do not produce physical goods and do not have the equipment that makes those goods-both of which are often used as collateral.

In business more oriented in financial transactions, the collateral will have to be pledged portions of profit, financial assets, property, and sometimes even personal collateral. For a new business that is not extremely stable, promising collateral can be a little bit intimidating.

Another disadvantage of secured loans is that they take longer to obtain than an unsecured loan. Secured loans take more paperwork because of the assets and collateral involved in the loan agreement.

This can be a major problem for businesses who need cash fast.